Arbitrage Opportunities – They Exist

Aug 30, 2008 by Adam C. Powell, Ph.D.

In business school, over the years, I have heard that in a perfect market, arbitrage opportunities should not exist. While this is true in theory, in practice, they do as the market is not perfect. An arbitrage occurs when a person buys an item from person A at one price, and then is able to immediately sell (arbitrage) that item to person B at a higher price. This should not be able to happen because person B should prefer to buy the item from person A directly, at the lower price. For this to happen, person B needs to be aware that person A is selling at the price at which he is selling.

That is the kicker; in real life, person B is often unaware that an item can more cheaply be purchased from person A than from a middle man. From what I have observed, it is precisely this type of arbitrage that is behind many small businesses on eBay. All too often, I will see an eBay listing for “new hard drives in perfect packaging, except for a missing UPC.” These hard drives are far from garage sale items; their purchasers have bought them in a sale and submitted a rebate using the UPCs. They have been purchased explicitly for resale on eBay. The arbitrage is possible if the sale prices were very favorable, and are not available to buyer by the time the products are listed. Furthermore, the buyer may be willing to pay a premium to not have to deal with the rebate. However, products arbitraged on eBay are not always items that were purchased in a sale that has ended. Some items are sold on websites that are not easily indexed by price comparison tools, and thus are unknown to potential shoppers. For instance, refurbished computers sold by their original manufacturer are not typically shown on Froogle.com, but are often cheaper than those listed on eBay.

Why isn’t everyone arbitraging items? There are two reasons. First of all, it is time-intensive to purchase, resell and ship items. Secondly, and more importantly, arbitrage is risky, especially if the goods in question are perishable. (While computer products do not “spoil,” they rapidly decline in value over time, which is a form of perishing.) Furthermore, there are substantial transaction costs involved in reselling an item. For a seller to make a profit, the final sale price must be enough to cover the cost of the item, shipping, eBay fees, and PayPal fees. As a result, it is only profitable to attempt to arbitrage an item if it can be resold for substantially more than it was purchased for. I once bought two dozen fine paintbrushes (hog and sable hair) for around $1 each. I thought it would be an excellent investment, as they normally cost several dollars. After selling one brush, I quickly realized that if I included the time that it took me to ship the brushes as a cost, it did not make financial sense to sell them. Sometimes, an arbitrage opportunity is not large enough for it to be worth the effort.