Let's meet the economy of Sri Lanka, an island nation situated in the Indian Ocean. The following

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Question:

Let's meet the economy of Sri Lanka, an island nation situated in the Indian Ocean.

The following two shocks occurred in the Sri Lankan economy during the period from 2020 to 2022.

i. As a result of the COVID-19 pandemic, Sri Lanka's tourism industry crashed. Tourism had traditionally been a major engine for economic growth in the country.

ii. Due to a plummeting foreign currency reserve, Sri Lanka faced mounting difficulties to import fuel (i.e., diesel and petrol). A fuel crisis ensued, with prices of petrol and diesel surging by more than double. In Sri Lanka, fuel is needed not only for transportation but also for electricity generation.

Required:

1) Considering the two shocks above, explain how Aggregate Demand (AD), Short-run Aggregate Supply (SRAS) and Long-run Aggregate Supply (LRAS) will be affected. (1 mark)

2) Draw an appropriate AD - AS graph to illustrate the impact of this shock. Assume the world economy is originally at the long-run equilibrium