Arbitrage: Profiteering from Resale

The holiday period is always a season for giving. For me this was no exception: I thought it’d be nice to buy back chocolates for my friends back home from my travels. But as I moved from shop to shop, it dawned on me that the same pack of chocolates was sold at different prices everywhere I went – searching for the best deal would always be part and parcel of any good shopper’s toolkit, and little did I know that the fluctuations in price would be so drastic. Street-side vendors would inflate the price of Ghiradelli chocolates to unreasonable amounts, citing the unparalleled convenience of purchasing from a street-side vendor.

I would fly back home to give away the Ghiradelli chocolates, some sea-salt flavoured, some filled with caramel, but like the sweet, sticky toffee that flows out of these chocolate squares, I knew that somewhere, seepage, arbitrage, was amiss.

Simply put, a person commits arbitrage when they buy cheaply and sell expensively. This is done in the hopes of earning a risk-free profit off the sale. Arbers take advantage of a price difference between two or more markets: striking a combination of matching deals that capitalise upon the imbalance, the profit being the difference between the market prices.

Arbitrage in modern times has become an issue in asset and financial markets with the volatility of the stock market and the buying and selling of shares. But for the longest time, arbitrage has been the target of intense debate when it comes to the law, and also from an economic point of view. This post will examine the legal and economic connotations of profiteering from resale, and what can be done to correct the market failure (if any) in markets where there are arbers about (alliteration!).

Legally, arbitrage technically isn’t a crime. So long as a buyer agrees to pay the higher price that is offered for sale, it is generally not unlawful as the buyer has consented to pay more than the market price. This is the beauty of the free market – price acts as a signal, and different consumers have different thresholds as to the maximum price they are willing to purchase an item for. Thus, even if the same good is being resold at a higher price, there may still be an efficient allocation of goods in the market as consumers willing to pay higher prices can purchase goods from arbers, while consumers who will only pay lower prices will simply find goods that are priced lower.

This brings to mind the economic concept of search costs. In George Stigler’s seminal work on “The Economics of Information”, he documents the existence of price dispersion empirically, and proceeds to sketch various theories that might be applicable to price dispersion. In essence, the differences in price due to resale are allowed to exist due to differences in the knowledge of consumers, knowledge which can only be gained through searching for information. The lack of information means that consumers are less able or find it less convenient to compare the prices of similar products, and thus, arbers can get away with selling more highly-priced goods, especially if the search costs are high.

This is where legal implications come into play, for the lack of information may actually lead to consumers being taken advantage of. In Singapore, for instance, arbitrage may be considered criminal if sellers are proven to have had a clear intent to deceive or cheat. A notable example would have been during the Sim Lim Square saga, where Jover Chew, owner of mobile phone reseller Mobile Air, notoriously sold mobile phones way above their normal retail price, on top of other dishonest practices.

Profiteering from resale is thus wholly inefficient and unfair in some cases, especially when they are in breach of the law. However, sometimes, the higher prices are actually offset by the lower search costs, which is why arbitrage continues to happen in the real world. To protect consumers from unfair resale, there are a few measures in place.

Under the principle of caveat emptor (buyer beware), the buyer cannot recover damages from the seller for defects on the property that rendered the property unfit for ordinary purposes, unless the seller actively concealed latent defects or otherwise made material misrepresentations amounting to fraud. This is a ruling principle in contract law that serves justice to the unsuspecting consumer.

From an economic point of view, to reduce information asymmetry between buyer and seller, screening is a method through which buyers can examine the quality of goods to see if they’re worth their price. By looking out for certain common universal standards such as warranties, awards, and the reputability of individual sellers or the components in the product, a buyer can make a more reasoned and informed choice.

Arbitrage doesn’t just hurt buyers, but can hurt sellers too. Many producers practice price discrimination, which is a pricing strategy that charges customers different prices for the same product or service. In pure price discrimination, the seller charges each customer the maximum price that he is willing to pay. This allows the producer to maximise profit. For instance, when charging commuters for a ride on the train, children, senior citizens or those riding at non-peak hour times will be charged lower fares to use the same service, while adults and riding during peak hours will incur higher fares.

Producers who practice price discrimination would not be fond of arbers – if producers are unable to prevent a particular group of buyers who purchased the goods at lower prices from reselling at higher prices, then buyers being charged higher prices would instead purchase from resellers, who would ideally sell at higher than what they were charged so that they can make a profit, but lower than what other buyers are being charged so that they can attract customers. This prevents the maximisation of profit. For instance, if a child could somehow sell his/her ticket to an adult to ride the train, the child could make a profit, while the train company will lose out on earning any money from potentially selling a ticket to the adult.

Thus, producers are also protected through laws that prevent arbitrage. Ticket scalping is a prominent example of arbitrage, in which consumers sell tickets they have bought for exorbitantly high prices, knowing that there is demand for these tickets. For instance, in Australia, the Queensland police are responsible for enforcing the law, and can issue on-the-spot fines to anyone committing a ticket scalping offence. Both buyers and sellers face penalties, though sellers face a higher maximum fine.

Original ticket sellers themselves can also protect their business, by invalidating the use of re-sold tickets, through methods such as only allowing credit card purchases to identify the original buyer. This dis-incentivises resale, since there is no longer demand for resold tickets.

When resale is everywhere and the difficulty of comparing prices continues to rise as more and more sellers flood the market, arbitrage can become a dangerous phenomenon for the everyday consumer and seller. Price controls are an extreme that prevent the functioning of the free market and can stymie the growth of sellers, while completely allowing resale may result in inefficient outcomes. Thus, striking a balance between unlawful resale as well as allocatively efficient resale, by better informing consumers, as well as developing techniques to prevent resale, can help to reduce the dangers of arbitrage.