Questions and explanations in Arbitrage.

You may wish to do these exercises with pencil and paper. Once you're finished click play to see a video explanation.

1. Apples are more expensive in the north than in the south of the country. Sketch two diagrams one for apples in the South and one for apples in the North. Label the axes. Mark in the equilibrium price and quantity in each market. Make sure the diagrams show the difference in the equilibrium price in the two markets.   

2. Profit motivated traders will now engage in arbitrage, buying up apples in the South and reselling them in the North. Show the effect of this process on the supply and demand diagrams in each market. Mark in the new equilibrium price in each market. What has happened to the price differential?

3. Your diagrams should show a reduction in the price differential but the two prices will still be different. Why will that be the case?

Last modified: Wednesday, March 7, 2012, 10:50 AM