Question 2 Country C is a steel exporting country. In value term, Country C’s exported steel represents about 80% of the GDP of Country C. All steel exported from Country C is exported to Country U....

Question 2

Country C is a steel exporting country. In value term, Country C’s exported steel represents about 80% of the GDP of Country C. All steel exported from Country C is exported to Country U. About 90% of the production in Country U uses steel from Country C. Country C also imports a large amount of soybeans from Country U. In value term, Country C’s imported soybeans from Country U is equivalent of 80% of the GDP of Country C. Imported soybeans are sold directly to households in Country C.

a. Suppose that Country U stops importing steel from Country C in order to protect its national security. If Country C does not retaliate, how will this ban on trade policy influence the equilibrium inflation rate and output in both Country C and Country U? Illustrate your answer with aggregate demand and aggregate supply diagrams relating inflation to output.

b. Suppose that Country C retaliates by stopping importing soybeans from Country U. How will this trade war between Country C and Country U affect the equilibrium inflation rate and output in both countries? Illustrate your answer with aggregate demand and aggregate supply diagrams relating inflation to output.