Tanzina Akter (13 th Batch)

CHAPTER-02,03, 04

 Question-01: DEFINE COMPARATIVE ADVANTGE OF INTERNATIONAL TRADE WITH SIMPLIFYING THE

EXAMPLE:

ANSWER:

The Law of Comparative Advantage : According to the law of comparative advantage, even if one nation is less
efficient than the other nation in the production of both commodities, there is still a basis for mutually
beneficial trade. The first nation should specialize in the production and export of the commodity in which its
absolute disadvantage is smaller and import the commodity in which its absolute disadvantage is greater (this
is the commodity of its comparative disadvantage).

Assumption:

 Two Countries, Both Producing Two Products

 Labor is the only factor of production and its productivity remains the same
 Perfect Mobility of labor between the sectors within a country
 No Mobility Of Labor between the Countries
 Assume Perfect Competition

-No Transportation Cost

- No restrictions on the movement of goods between the countries ( Free Trade)

 QUESTION-02: PRODUCTION POSSIBILITIES IN THE UNITED STATES AND UNITED KINGDOM AS FOLLOWS:

US UK
Wheat ( Bushles/ Man- Hour) 6 1
Cloth ( Yards/ Man- Hour 4 2

Suppose that US exchange 6w for 6c with the UK.

a. How Much does the US gain and Uk gain

b. What is the range for Mutual Beneficial Trade?
c. What is the dollar price of wheat and cloth in the United Kingdom if the exchange rate between
the pound and the dollar is £1 = $2? Would the United States be able to export wheat to the
United Kingdom at this exchange rate? Would the United Kingdom be able to export cloth to the
United States at this exchange rate?
d. What if the exchange rate between the dollar and the pound were £1 = $3? What if the
exchange rate were £1 = $1?

Answer:

(a)

The United States would gain 2C (or save 1/ 2 hour of labor time) since the United States could only exchange
6W for 4C domestically.

United Kingdom would also gain, note that the 6W that the United Kingdom receives from the United States
would require six hours to produce in the United Kingdom. The United Kingdom could instead use these six
hours to produce 12C and give up only 6C for 6W from the United States. Thus, the United Kingdom would
gain 6C or save three hours of labor time.

(b)

Here, US exchange 6W for 6C with the UK. However, this is not the only rate of exchange at which mutually
beneficial trade can take place. Since the United States could exchange 6W for 4C domestically (in the sense
that both require 1 hour to produce,

The United States would gain if it could exchange 6W for more than 4C from the United Kingdom. On the
other hand, in the United Kingdom 6W = 12C (in the sense that both require 6 hours to produce). Anything less
than 12C that the United Kingdom must give up to obtain 6W from the United States represents a gain from
trade for the United Kingdom.

To summarize, the United States gains to the extent that it can exchange 6W for more than 4C from the United
Kingdom.

The United Kingdom gains to the extent that it can give up less than 12C for 6W from the United States. Thus,
the range for mutually advantageous trade is

4C < 6W < 12C

(c)

Suppose that the wage rate in the United States is $6 per Hour and e the wage rate in Uk is £1. So the price of
the wheat and Cloth in US and uk is as follows:

US UK
Price of wheat $1 £1
Price of Cloth $1.50 £0.5

If the exchange rate between the pound and the dollar is £1 = $2 , then

Dollar Price of Wheat and Cloth in the United States and United Kingdom at £1 = $2
US UK
Pw $1 $2
Pc $1.50 $1

From Table, we can see that the dollar price of Wheat is lower in the United States than in the United
Kingdom. On the other hand, the dollar price of cloth is lower in the United Kingdom.

With the dollar price of wheat lower in the United States, businesspeople would buy wheat there and sell it in
the United Kingdom, where they would buy cloth to sell in the United States. Even though U.K. labor is half as
productive as U.S. labor in cloth production, U.K. labor receives only one-third of the U.S. wage rate (£1 = $2 as
opposed to $6 in the United States), so that the dollar price of cloth is lower in the United Kingdom.

To put it differently, the inefficiency of U.K. labor relative to U.S. labor in cloth production is more than
compensated for by the lower wages in the United Kingdom. As a result, the dollar price of cloth is less in the
United Kingdom, so the United Kingdom can export cloth to the United States.
 (d)

Dollar Price of Wheat and Cloth in the United States and United Kingdom at £1 = $1
US UK
Pw $1 $1
Pc $1.50 $0.50

If the exchange rate between the dollar and the pound were instead £1 = $1, then the dollar price of wheat in
the United Kingdom would be PW = £1 = $1. Since this is the same price as in the United States, the United
States could not export wheat to the United Kingdom at this exchange rate. At the same time, PC = £0.5 =
$0.50 in the United Kingdom, and the United Kingdom would export even more cloth than before to the
United States. Trade would be unbalanced in favor of the United Kingdom, and the exchange rate between the
dollar and the pound would have to rise.

Dollar Price of Wheat and Cloth in the United States and United Kingdom at £1 = $3
US UK
Pw $1 $3
Pc $1.50 $1.50

if the exchange rate were £1 = $3, the price of cloth in the United Kingdom would be PC = £0.5 = $1.50. As a
result, the United Kingdom could not export cloth to the United States. Trade would be unbalanced in favor of
the United States, and the exchange rate would have to fall. The rate of exchange between the dollar and the
pound will eventually settle at the level that will result in balanced trade (in the absence of any interferences
or other international transactions).

US UK
 Wheat ( Bushles/ Man- 4 1 QUESTION-
03: Hour)
Cloth ( Yards/ Man- Hour 3 2
PRODUCTION POSSIBILITIES IN THE UNITED STATES AND UNITED KINGDOM AS FOLLOWS:

Suppose that US exchange 4w for 4c with the UK.

a) How Much does the US gain and Uk gain

b) What is the range for Mutual Beneficial Trade?
c) What is the dollar price of wheat and cloth in the United Kingdom if the exchange rate between the
pound and the dollar is £1 = $2? Would the United States be able to export wheat to the United
 Kingdom at this exchange rate? Would the United Kingdom be able to export cloth to the United
States at this exchange rate?
d) What if the exchange rate between the dollar and the pound were £1 = $4? What if the exchange rate
were £1 =$1

(a)

The United States would gain 1C (or save 1/ 3 hour of labor time) since the United States could only exchange
4W for 3C domestically.

United Kingdom would also gain, note that the 4W that the United Kingdom receives from the United States
would require four hours to produce in the United Kingdom. The United Kingdom could instead use these four
hours to produce 8C and give up only 4C for 4W from the United States. Thus, the United Kingdom would gain
4C or save two hours of labor time.

(b)

Here, US exchange 4W for 4C with the UK. However, this is not the only rate of exchange at which mutually
beneficial trade can take place. Since the United States could exchange 4W for 3C domestically.

The United States would gain if it could exchange 4W for more than 3C from the United Kingdom. On the
other hand, in the United Kingdom 4W = 8C. Anything less than 8C that the United Kingdom must give up to
obtain 4W from the United States represents a gain from trade for the United Kingdom.

To summarize, the United States gains to the extent that it can exchange 4W for more than 3C from the United
Kingdom.

The United Kingdom gains to the extent that it can give up less than 8C for 4W from the United States. Thus,
the range for mutually advantageous trade is

3C < 4W < 8C

(c)

Suppose that the wage rate in the United States is $6 per Hour and e the wage rate in Uk is £1. So the price of
the wheat and Cloth in US and uk is as follows:

US UK
Price of wheat $1.50 £1
Price of Cloth $2 £0.5

If the exchange rate between the pound and the dollar is £1 = $2 , then

Dollar Price of Wheat and Cloth in the United States and United Kingdom at £1 = $2
US UK
Pw $1.5 $2
Pc $2 $1
From Table , we can see that the dollar price of wheat is lower in the United States than in the United
Kingdom. On the other hand, the dollar price of cloth is lower in the United Kingdom.

With the dollar price of wheat lower in the United States, businesspeople would buy wheat there and sell it in
the United Kingdom, where they would buy cloth to sell in the United States.

To put it differently, the inefficiency of U.K. labor relative to U.S. labor in cloth production is more than
compensated for by the lower wages in the United Kingdom. As a result, the dollar price of cloth is less in the
United Kingdom, so the United Kingdom can export cloth to the United States.

(d)

Dollar Price of Wheat and Cloth in the United States and United Kingdom at £1 = $4
US UK
Pw $1.5 $1.5
Pc $2 $2

In this case, the only trade would be the export of wheat from the US to t he UK. They are Indifferent about
the cloth trade, So mutually beneficially trade cannot take place. Only one-sided trade is unbalanced trade.

The dollar price of pound is expected to fall in this case, making the trade balanced at a certain exchange rate.

Dollar Price of Wheat and Cloth in the United States and United Kingdom at £1 = $1
US UK
Pw $1.5 $1
Pc $2 $0.5

All the export is done by the UK. Abother example of unbalance trade. In this case, the dollar proce of the
pound is expected to ise until it becomes a balance trade where both actors can export.

 QUESTION-04: WHY IS A NATION’S PRODUCTION POSSIBILITY FRONTIER THE SAME AS ITS

CONSUMPTION FRONTIER IN THE ABSENCE OF TRADE? HOW DOES THE NATION DECIDE HOW
MUCH OF EACH COMMODITY TO CONSUME IN THE ABSENCE OF TRADE?

ANSWER

- The production possibilities frontier shows combinations of goods a country can produce.

With trade, each nation can specialize in producing the commodity of its comparative advantage and
exchange part of its output with the other nation for the commodity of its comparative disadvantage. By so
doing, both nations end up consuming more of both commodities than without trade.

In the absence of trade, a nation can only consume the commodities that it produces. As a result, the nation’s
production possibility frontier also represents its consumption frontier. Which combination of commodities
the nation actually chooses to produce and consume depends on the people’s tastes, or demand
considerations.

- A nation can make its decision in consuming each commodity through its PPF.
In the absence of trade, the
United States might choose to produce and consume combination A (90W and 60C) on its production
possibility frontier , and the United Kingdom might choose combination A’ (40W and 40C)

With trade possible, the United States would specialize in the production of wheat and produce at point B
(180W and 0C) on its production possibility frontier. Similarly, the United Kingdom would specialize in the
production of cloth and produce at B (0W and 120C). If the United States then exchanges 70W for 70C with the
United Kingdom, it ends up consuming at point E , and the United Kingdom ends up consuming at E’. Thus, the
United States gains 20W and 10C from trade , and the United Kingdom gains 30W and 10c.

The increased consumption of both wheat and cloth in both nations was made possible by the increased
output that resulted as each nation specialized in the production of the commodity of its comparative
advantage. That is, in the absence of trade, the United States produced 90W and the United Kingdom 40W, for
a total of 130W. With specialization in production and trade, 180W are produced (all in the United States).
Similarly, in the absence of trade, the United States produced 60C and the United Kingdom 40C, for a total of
100C. With specialization in production and trade, 120C are produced (all in the United Kingdom).

It is this increase in output of 50W and 20C resulting from specialization in production that is shared by the
United States and the United Kingdom and represents their gains from trade. Recall that in the absence of
trade, the United States would not specialize in the production of wheat because it also wanted to consume
some cloth. Similarly, the United Kingdom would not specialize in the production of cloth in the absence of
trade because it also wanted to consume some wheat.

 QUESTION-05: WHAT IS MEANT BY COMPLETE SPECIALIZATION AND INCOMPLETE SPECIALIZATION?

WHY DO BOTH NATIONS GAIN FROM TRADE IN THE FIRST INSTANCE BUT ONLY THE SMALL NATION
IN THE SECOND?

Complete Specialization: Complete specialization means the utilization of all of a nation’s resources in the
production of only one commodity with trade. This usually occurs under constant costs.

Incomplete Specialization: Incomplete specialization means the continued production of both commodities in
both nations with increasing costs, even in a small nation with trade
.
The situation occurs that in the first instance, both nations gain from trade; however, in the second, only the
small one can have the advantage. For this reason, both nations gain by its own
comparative advantage. The small nation gains in the second thanks to its complete specialization and a
smaller market compared to the big country

 QUESTION-06: HOW IS THE COMBINED SUPPLY CURVE OF BOTH NATIONS FOR EACH OF THE
TRADED COMMODITIES DETERMINED? HOW IS THE EQUILIBRIUM-RELATIVE COMMODITY PRICE
DETERMINED WITH TRADE?

The combined supply curve of both nations for each of the traded commodities is determined as  a sum of
national supply of each country.
Equilibrium-Relative Commodity Price determined with trade:   The equilibrium-relative commodity price
with trade is the common relative price in both nations at which trade is balanced. With trade, the
equilibrium relative commodity price of each commodity is between the pre trade relative commodity price in
each nation.

Below Figure will also help us see how the equilibrium-relative commodity price with specialization in
production and trade is determined:

In the left panel, SW (US+UK) is the combined supply curve of wheat of the United States and the United
Kingdom if both countries used all of their resources to produce only wheat. It shows that the United States
could produce a maximum of 180W = 0B at PW/PC = 2/3. On the other hand, the United Kingdom could
produce a maximum of 60W = BB∗ at the opportunity cost PW/PC = 2. Thus, 240W is the maximum combined
total quantity of wheat that the United States and the United Kingdom could produce if both nations used all
of their resources to produce wheat. As a result, the SW (US+UK) curve is vertical at 240W.

Suppose that, with trade, the combined demand curve for cloth of the United States and the United Kingdom
is DW (US+UK). . DW (US+UK) intersects SW (US+UK) at point E, determining the equilibrium quantity of 180W
and the equilibrium relative price of PW /PC = 1 with trade. , with trade, wheat is produced only in the
United States, and the United States specializes completely in the production of wheat.

In the right panel of Figure , SC(UK+US ) is the combined supply curve of cloth of the United Kingdom and the
United States if both countries used all of their resources to produce only cloth. The United Kingdom can
produce a maximum of 120C = 0B’ at the constant PC /PW = 1/ 2 and the United States can produce a
maximum of another 120C = B’ B’’ at the constant PC /PW = 3/ 2 . with trade, cloth is produced only in the
United Kingdom, and the United Kingdom specializes completely in the production of cloth.

with trade, the combined demand for cloth of the United Kingdom and the United States is DC(UK+US ). .
DC(UK+US ) intersects SC(UK+US ) at point E’ , determining the equilibrium quantity of 120C and the
equilibrium-relative price of PC /PW = PW /PC = 1.

However, if in the left panel of Figure 2.3 DW (US+UK) were lower and intersected SW (US+UK) between points
0 and B on the horizontal portion of SW (US+UK) at PW /PC = 2/ 3, trade would take place at the pretrade
relative commodity price of wheat of PW /PC = 2/ 3 in the United States and the United Kingdom would
receive all the gains from trade.

 QUESTION-06: IN WHAT WAY INCOMPLETE SPECIALIZATION IN PRODUCTION DIFFER FROM

COMPLETE SPECIALIZATION. IF TWO NATIONS HAVE IDENTICAL PRODUCTION POSSIBILITY
FRONTIER, WHAT WILL BE BASIS FOR MUTUALLY BENEFICIAL TRADE?

The way incomplete specialization in production differ from complete specialization:

Under constant costs, each nation specializes completely in production of the commodity of its comparative
advantage. The reason is that since it pays for the nation to obtain some of the commodity of its comparative
disadvantage from the other nation, then it pays for the nation to get all of the commodity of its comparative
disadvantage from the other nation.

In contrast , With increasing costs, specialization in production is incomplete in production in both nations.

For example: while Nation 1 produces more of X (the commodity of its comparative advantage) with trade, it
continues to produce some Y. Similarly, Nation 2 continues to produce some X with trade. The reason for this
is that as Nation 1 specializes in the production of X, it incurs increasing opportunity costs in producing X.
Similarly, as Nation 2 produces more Y, it incurs increasing opportunity costs in Y (which means declining
opportunity costs of X).

Thus, As each nation specializes in the production of the commodity of its comparative advantage, the relative
commodity price in each nation moves toward each other(i.e., become less unequal) until they are identical in
both nations. At that point, it does not pay for either nation to continue to expand the production of the
commodity of its initial comparative advantage. This occurs before either nation has completely specialized in
production.

if two nations have identical production possibility frontiers (which is unlikely), there will still be a basis for
mutually beneficial trade if tastes, or demand preferences, in the two nations differ. The nation with the
relatively smaller demand or preference for a commodity will have a lower autarky-relative price for, and a
comparative advantage in, that commodity.

Illustration of Trade Based on Differences in Tastes:

Trade based solely on differences in tastes is illustrated in Figure. Since the production frontiers of the two
nations are now assumed to be identical, they are represented by a single curve. With indifference curve I
tangent to the production frontier at point A for Nation 1 and indifference curve Itangent at point Afor Nation
2, the pre trade-relative price of X is lower in Nation 1. Thus, Nation 1 has a comparative advantage in
commodity X and Nation 2 in commodity Y.

With the opening of trade, Nation 1 specializes in the production of X, while Nation2 specializes in Y.
Specialization continues until PX /PY is the same in both nations and trade is balanced. This occurs at point B
(which coincides with point B’), where PB = PB’= 1. Nation 1 then exchanges 60X for 60Y with Nation 2 and
ends up consuming at point E on its indifference curve III. Nation 1 thus gains 20X and 20Y as compared with
point A.

Similarly, Nation 2 exchanges 60Y for 60X with Nation 1 and ends up consuming at point E’ on its indifference
curve III’ (also gaining 20X and 20Y from point A’ ). Note that when trade is based solely on taste differences,
the patterns of production become more similar as both nations depart from autarky.

Thus, mutually beneficial trade can be based exclusively on a difference in tastes between two nations.
 
 Question-07 : How can the supply curve of exports and the demand curve of imports of a
commodity be derived from the total demand and supply curves of a commodity in the
two nations? And How is the equilibrium-relative commodity price with trade determined
with demand and supply Curve?

= The excess supply of a commodity above the no-trade equilibrium price gives one nation’s export
supply of the commodity. On the other hand, the excess demand of a commodity below the no-
trade equilibrium price gives the other nation’s import demand for the commodity.

The intersection of the demand curve for imports and the supply curve for exports of the
commmodity defines the partial equilibrium-relative price and quantity of the commodity at which
trade takes place.

We can derived the demand for imports and the supply of exports of the traded commodity from
the total demand and supply curve and used them to determine the equilibrium volume of trade and
the equilibrium-relative commodity price at which trade takes place between the two nations.This is
shown in below figure:

In this figure, Curves DX and SX in panels A and C refer to the demand and supply curves for
commodity X of Nation 1 and Nation 2, respectively. The vertical axes in all three panels of Figure
measure the relative price of commodity X. The horizontal axes measure the quantities of
commodity X.

panel A shows that at P1, the quantity supplied of commodity X (QSX ) equals the quantity
demanded of commodity X (QDX ) in Nation 1, and so Nation 1 exports nothing of commodity X. This
gives point A ∗ on curve S (Nation 1’s supply curve of exports) in panel B.

Panel A also shows that at P2, the excess of BE of QSX over QDX represents the quantity of
commodity X that Nation 1 would export at P2. This is equal to B∗ E∗ in panel B and defines point E∗
on Nation 1’s S curve of exports of commodity X.
On the other hand, panel C shows that at P3, QDX = QSX (point A’ ), so Nation 2 does not demand
any imports of commodity X. This defines point A’’ on Nation 2’s demand curve for imports of
commodity X (D) in panel B.

Panel C also shows that at P2, the excess B’E’ of QDX over QSX represents the quantity of
commodity X that Nation 2 would import at P2. This is equal to B∗ E∗ in panel B and defines point E∗
on Nation 2’s D curve of imports of commodity X.

At P2, the quantity of imports of commodity X demanded by Nation 2 (B’ E’ in panel C) equals the
quantity of exports of commodity X supplied by Nation 1 (BE in panel A). This is shown by the
intersection of the D and S curves for trade in commodity X in panel B.

Thus, P2 is the equilibrium-relative price of commodity X with trade. From panel B we can also see
that at PX /PY > P2 the quantity of exports of commodity X supplied exceeds the quantity of imports
demanded, and so the relative price of X (PX /PY ) will fall to P2. On the contrary, at PX /PY < P2, the
quantity of imports of commodity X demanded exceeds the quantity of exports supplied, and PX /PY
will rise to P2.

 Question-08: What do offer curves show? How are they derived? What is their shape?
How do offer curves define Meade’s general trade model.
The offer curve of a nation shows how much of its import commodity the nation demands for it to be willing to
supply various amounts of its export commodity.

The offer curve of a nation can be derived from its production frontier, its indifference map, and the various
relative commodity prices at which trade could take place.

For the derivation of the offer curve of a nation, it is supposed that there are two Nation: Nation 1 and Nation
2.

Graphically shows Derivation of the Offer Curve of Nation 1.:

The Left Panel Represents the production and consumption points of Nation 1 in the form of possibility
frontiers and community indifference curves. Nation 1 specialises in X.

The right panel plots various combination of commodity X and Y are exchanged.

In the left panel, Nation 1 starts at pre trade-equilibrium point A. If trade takes place at PB = 1, Nation 1 moves
to point B in production, exchanges 60X for 60Y with Nation 2, and reaches point E. This gives point E in the
right panel. At PF = 1/ 2 in the left panel, Nation 1 would move instead from point A to point F in production,
exchange 40X for 20Y with Nation 2, and reach point H. This gives point H in the right panel. Joining the origin
with points H and E in the right panel, we generate Nation 1’s offer curve. This shows how many imports of
commodity Y Nation 1 requires to be willing to export various quantities of commodity X.
Derivation of the Offer Curve of Nation 2:

In the left panel, Nation 2 starts at pretrade equilibrium point A’ . If trade takes place at PB’ = 1, Nation 2
moves to point B’ in production, exchanges 60Y for 60X with Nation 1, and reaches point E’ . This gives point E’
in the right panel. At PF’ = 2 in the left panel, Nation 2 would move instead from A’ to F’ in production,
exchange 40Y for 20X with Nation 1, and reach H’. This gives point H’ in the right panel. Joining the origin with
points H’ and E’ in the right panel, we generate Nation 2’s offer curve. This shows how many imports of
commodity X Nation 2 demands to be willing to supply various amounts of commodity Y for export.

offer curves define Meade’s general trade model:

The intersection of the offer curves of the two nations defines the equilibrium-relative commodity price at
which trade takes place between them. Only at this equilibrium price will trade be balanced between the two
nations. At any other relative commodity price, the desired quantities of imports and exports of the two
commodities would not be equal. This would put pressure on the relative commodity price to move toward its
equilibrium level. This is shown in figure:

The offer curves of Nation 1 and Nation two intersect at point E, defining equilibrium PX /PY = PB = PB’ = 1.
At PB , Nation 1 offers 60X for 60Y (point E on Nation 1’s offer curve), and Nation 2 offers exactly 60Y for 60X
(point E’ on Nation 2’s offer curve). Thus, trade is in equilibrium at PB . At any other PX /PY , trade would not
be in equilibrium.

For example, at PF = 1/ 2, the 40X that Nation 1 would export ( point H) would fall short of the imports of
commodity X demanded by Nation 2 at this relatively low price of X. The excess import demand for
commodity X at PF = 1/ 2 by Nation 2 tends to drive PX /PY up. As this occurs, Nation 1 will supply more of
commodity X for export (i.e., Nation 1 will move up its offer curve), while Nation 2 will reduce its import
demand for commodity X (i.e., Nation 2 will move down its offer curve). This will continue until supply and
demand become equal at PB .

 Question: In what way is partial equilibrium analysis of trade related to general equilibrium
analysis?

We can illustrate the equilibrium-relative commmodity price and quantity with trade with partial equilibrium
analysis. This makes use of the demand and supply curves for the traded commodities. These are derived from
the nations’ production frontiers and indifference maps—the same basic information from which the nations’
offer curves (which are used in general equilibrium analysis) are derived.

Relationship between General and Partial Equilibrium Analyses is shown in below figure:

In Figure , S is Nation 1’s

supply curve of exports of commodity X and is derived from Nation 1’s production frontier and
indifference map. Specifically, S shows that the quantity supplied of exports of commodity X by
Nation 1 is zero (point A) at PX /PY = 1/ 4, 40 (point H ) at PX /PY = 1/ 2, and 60 (point E) at PX /PY
=1 .

On the other hand, D refers to Nation 2’s demand for Nation 1’s exports of commodity X and is
derived from Nation 2’s production frontier and indifference map . Specifically, D in Figure 4.6
shows that the quantity demanded of Nation 1’s exports of commodity X by Nation 2 is 60 (point E)
at PX /PY = 1 , 120 (point H ‘ ) at PX /PY = 1/ 2, but 40 (point R’ ) at PX /PY = 11/ 2.

D and S intersect at point E in Figure 4.6, determining the equilibrium PX /PY = 1 and the equilibrium
quantity of exports of 60X .

Figure shows that at PX /PY = 11/ 2 there is an excess supply of exports of R’ R = 30X, and PX /PY
falls toward equilibrium PX /PY = 1. On the other hand, at PX /PY = 1/ 2, there is an excess demand of
exports of HH ‘ = 80X, and PX /PY rises toward PX /PY = 1.
 Thus, the relative price of X gravitates toward the equilibrium price of PX /PY = 1, given by point E in
Figure.