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Free response question

Macroeconomics · Hard · 20 marks

EO past paper: 2026 International Final, Macroeconomics paper

Effects of a Fuel-Price Increase on Inflation and a Transport Business (20 points) Alexandra operates Alexandra Offroad as a sole proprietor. So, her business income is treated as personal income for tax purposes, and she directly bears all business risks. She charges clients a per-kilometer rate that includes a fuel surcharge (an added fee, separate from her base rate, to help offset rising diesel costs). Value-added tax (VAT) is excluded from all calculations. The closure of the Strait of Hormuz causes gasoline and diesel prices to increase by 25%. Fuel accounts for 3% of the Consumer Price Index (CPI); prices of all other goods and services rise by 1%.

(a)Part A. Inflation: Assume the CPI initially equals 100 and calculate the new CPI and the resulting inflation rate.[2](b)Part B. Profit Before the fuel-price increase: - Alexandra charged a base rate of $1.70 per kilometer (before the fuel surcharge) and drove 27,000 paid kilometers per month. - Monthly fixed costs were $20,000. - Variable cost was $0.64 per kilometer, of which 52% was fuel and 48% was non-fuel cost. (Assume non-fuel variable costs remain unchanged throughout this problem.) - Diesel cost $1.80 per liter, and Alexandra applied a 3% fuel surcharge on her base rate to help cover fuel expenses. After the 25% increase: - Diesel costs $2.25 per liter, and Alexandra raises her fuel surcharge to 8% on her base rate. - The number of paid kilometers falls to 25,820. - Fixed costs increase strictly by the inflation rate calculated in Part A. This is the sole source of the fixed-cost increase, since no other cost driver is introduced. Calculate: 1. Alexandra's monthly profit before the fuel price increase. 2. Alexandra's monthly profit after the fuel-price increase. 3. The dollar change in monthly profit. Show all work, rounding answers to nearest hundredth (two decimal places).[14](c)Part C. Risky Business: Explain how higher fuel prices increase Alexandra's business risk. Refer to both fixed and variable costs.[2](d)Part D. Purchasing Power: Alexandra pays 20% income tax. Using your answers from Parts A and B, determine whether Alexandra's purchasing power increased or decreased and by what percentage, showing your work and rounding answers to nearest hundredth (two decimal places).[2]

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