Arbitrage

What is arbitrage? Arbitrage is when you buy low and then sell high. More specifically, you buy a low-priced good in one market and resell that same good in a market where its price is higher. The effect of arbitrage is to bring the prices in those two markets closer together, therefore making it more difficult for firms to price discriminate.

Let's see this with an example. Rohm and Haas was a producer of a special plastic material that had uses in both industry and dentistry. This plastic had a variety of substitutes in industry, but very few substitutes in dentistry. Therefore, it was less expensive in industry than in dentistry -- 85 cents per pound versus $22 per pound. Of course, with a price difference like that, entrepreneurs started to arbitrage -- to buy up the industrial plastic, convert it to the plastic for dentures, and then resell that plastic at the higher price.

But before the prices could adjust from arbitrage, Rohm and Haas took drastic measures to prevent arbitrage from happening. Now this prevention of arbitrage isn't the norm though. In fact, arbitrage is working behind the scenes to prevent price discrimination in almost all goods markets.