Mauritius is an island nation off the coast of the African continent in the Indian Ocean. At various points in its history, it has been a Dutch colony, a French colony, and a British colony and it gained its independence in 1968. It has many lovely beaches and is a major destination for parasailing, SCUBA diving, and water skiing. The country generally has good governance and free trade. The population is approximately 1.4MM people. GDP over the last few years has been growing steadily from $25.5B in 2015 to $28B in 2018 (estimated) – which translates into an average growth rate of 3.9%. GDP per capita is $21,600 and the unemployment rate is 6.9%. Assume Mauritius is a small open economy. Further, assume that the world interest rate (r*) and the equilibrium interest rate of Mauritius (r c – the interest rate in Mauritius if it were a closed economy) are equal to each other.

a) Imagine now that a new Prime Minister and Parliament are elected in Mauritius. The new administration and Parliament believe strongly in expansionary fiscal policy and they increase government spending. Draw and properly label the appropriate graph, including the initial state and the results of the government’s action. Explain below what happens to the relevant economic variables.