Fundamentals of Financial Planning Flashcards
Question
With regard to debt management, a good rule of thumb is to:
A) Keep 3 to 6 months expenses available for an emergency fund.
B) Total debt should not exceed 28% of gross monthly income.
C) Consumer debt should not exceed 28% of net monthly income.
D) Housing debt should not exceed 28% of gross monthly income.
Solution: The correct answer is D.
Emergency fund rule is correct, at 3 to 6 months, but has nothing to do with debt management. Total debt should not exceed 36% of gross income. Consumer debt should not exceed 20% of net income.
As a rule of thumb, it is best if consumer debt does not exceed:
A) 20% of net income.
B) 20% of gross income.
C) 3 to 6 months of expenses.
D) 36% of gross monthly income.
Solution
Solution: The correct answer is A.
This is a rule of thumb, consumers should not be spending more than 20% of their take home pay (net income) on consumer debt (credit cards). This rule of thumb should factor along with the other recommendations for housing debt to be limited to 28% of gross income, and total debt not to exceed 36% of gross income.
Kim and Mark make $65,000 per year combined gross income. Their housing costs are $1,625 per month, while another $300 per month covers the balance of any other debt they currently owe. Other household expenses bring their total expenses to $3,200 per month.
The total portion of their obligations that are monthly interest payments (included in the mortgage and other debt amounts) is $1,000. Their take home averages $3,500 per month. Over the last several years, they have managed to save 3% to 5% of their income. They have set aside $22,400 in money market funds.
Select “A” if their total debt can be considered a strength.
Select “B” if their total debt can be considered a weakness.
Their total debt can be considered a strength.
Their total debt can be considered a weakness.
Solution: The correct answer is A.
Their total amount of obligation is reasonable. Total debt should not exceed 36% of gross income of the client.
Total debt is $1,625 + $300 = $1,925. Total $1,925 / (65,000/12) = 35.5%. As their total debt is less than 36%, it is considered a strength.
Kim and Mark make $65,000 per year combined gross income. Their housing costs are $1,625 per month, while another $300 covers the balance of any other debt they currently owe. Other household expenses bring their total expenses to $3,200 per month.
The total portion of their obligations that are monthly interest payments (included in the mortgage and other debt amounts) is $1,000. Their take home averages $3,500 per month. Over the last several years, they have managed to save 3% to 5% of their income. They have set aside $22,400 in money market funds. Select “A” if their emergency fund can be considered a strength. Select “B” if their emergency fund can be considered a weakness.
Their emergency fund is a strength.
Their emergency fund is a weakness.
Solution: The correct answer is A.
Emergency funds can be used to cover 3-6 months of income or 3-6 months of non-discretionary expenses. Using income allows current savings goals to still be accomplished. They have a very respectable 3-6 months of emergency funds.
3 – 6 months of take home pay of $3,500 over the three to six months is a range of 10,500 - 21,000
3 – 6 month non-discretionary expenses of 3,200 over the three to six months is a range of 9,600 – 19,200 (the CFP® exam leans this way)
Had the question asked about the emergency fund ratio, you would then use cash and cash equivalents divided by monthly non-discretionary cash flows.
The First Practice Standard - Understanding The Client’s Personal and Financial Circumstances is a good place to:
A) Construct and send the client an information organizer.
B) Establish which services will be provided during the engagement.
C) Undertake teambuilding and networking with other professionals who are already working with the client.
D) Modify goals if need be during this step.
Solution: The correct answer is A.
Option “B” is prior to step one. Options “C” and “D” are step three - trend analysis and information evaluation.
Arrange the following financial planning steps into the proper sequence in which these functions are performed by a CFP® Professional:
I) Understanding The Client’s Personal and Financial Circumstances
II) Presenting the Financial Planning Recommendation(s)
III) Analyzing the Client’s Current Course of Action and Potential Alternative Course(s) of Action
IV) Developing the Financial Planning Recommendation(s)
V) Identifying and Selecting Goals
A) I, III, V, IV and then II.
B) V, I, III, II and then IV.
C) I, V, IV, III and then II.
D) I, V, III, IV and then II.
Solution: The correct answer is D.
The proper sequence of practice standard steps is to – Understanding The Client’s Personal and Financial Circumstances, Identifying and Selecting Goals, Analyzing the Client’s Current Course of Action and Potential Alternative Course(s) of Action, Developing the Financial Planning Recommendation(s), Presenting the Financial Planning Recommendation(s), Implementing the Financial Planning Recommendation(s), Monitoring Progress and Updating
Of the following situations, when should a pre-marital agreement NOT be considered by individuals contemplating marriage?
A) When one or both parties are unwilling to make a full disclosure of all their income and assets to the other party.
B) When each party has significant wealth and wishes to protect his/her financial independence.
C) When there is a significant difference in wealth of each party.
D) When one or both parties have ongoing obligations, rights and/or children from a previous marriage.
Solution: The correct answer is A.
Without full disclosure of the assets of both parties, it is not possible to arrive at a fair arrangement for a prenuptial agreement. All other answers are suitable for premarital agreements.
Quantitative vs Qualitative
Bob Blazek comes to you, his financial planner and a CFP® certificant, with a question about a recent agreement he made. His brother Bill asked to borrow $10,000 to start a new business. What advice do you give Bob to help make this a successful transaction?
- Make a formal arrangement specifying the interest rate and repayment schedule.
- State in writing that this is a loan, NOT a gift, and have Bill sign the document.
- Explain to Bob his options in case of default.
- Make sure Bob approves of the business venture prior to making the loan.
- I and IV only.II and III only.
- II and IV only.
- I, II and III only.
Solution: The correct answer is D.
All choices are good advice, except for Option “IV.” If Bob does not approve of the business venture, he need not loan Bill the money. Based on the facts, he has already decided to loan the money by coming to you for information on how to accomplish it.
Six months ago, a client purchased a new bedroom suite for $6,500. For purposes of preparing accurate financial statements, this purchase would appear as a (an): (CFP® Certification Examination released 3/95)
- Personal use asset on the client’s net worth statement.
- Investment asset on the client’s net worth statement.
- Variable outflow on a client’s historic cash flow statement.
- Fixed outflow on the client’s cash flow statement.
A) 1, 2 and 3
B) 1 and 3
C) 4 only
D) 2 and 4
Solution: The correct answer is B.
Variable outflow because it’s not a recurring expense, such as a debt payment.
A client having a real estate asset in his portfolio wishes to know its value. The estimated value of this real estate asset in the financial statement prepared by you as a Professional Financial Planner should be based upon the:
- Basis of the asset, after taking into account all straight line and accelerated depreciation.
- Client’s estimate of current value.
- Current replacement value of the asset.
- Value that a well-informed buyer is willing to accept from a well-informed seller where NEITHER is compelled to buy or sell.
Solution: The correct answer is D.
The value of all assets should have their basis in current market value which is defined best in Option “D.
A client provides a current personal balance sheet to the financial planner during the initial data gathering phase of the financial planning process. This financial statement will enable the financial planner to gain an understanding of all of the following EXCEPT the:
- Diversification of the client’s assets.
- Size of the client’s net cash flow.
- Client’s liquidity position.
- Client’s use of debt.
Solution: The correct answer is B.
Assets and liabilities show up on a balance sheet, while cash flows are demonstrated on a statement of earnings also known as a personal cash flow statement (statement of income and expenses).
Which of the following terms best describes assets such as savings accounts, stocks, bonds, mutual funds?
- Tangible assets.
- Liquid assets.
- Use assets.
- Financial assets
Solution: The correct answer is D.
All of the above are financial assets, also known as intangible assets. Tangible assets could be your furniture, liquid assets are made up of cash, but not stocks, bonds and mutual funds, and use assets could be your car or home.
In analyzing the financial statements of a client’s business, you notice the collection period for accounts receivable has been increasing. What does this increase suggest about the firm’s credit policy?
- The firm’s current ratio is also increasing.
- The collection period has NO relationship to a firm’s credit policy.
- The firm is losing qualified customers.
- The credit policy is too lenient.
Solution: The correct answer is D.
Longer periods of time for collection of receivables indicates less money collected, and less to use by your client’s firm.
Robert Smith asks for your help in preparing his cash flow statement. He tells you that his salary before taxes is $250,000 and that he has NO mortgage on his home. Which of the following statements is true about Robert’s cash flow statement?
- The value of the home would be an income source, since there is NO mortgage.
- The value of the home would be an asset.
- The taxes on his salary would be a liability.
- The taxes on his salary would be an expense.
Solution: The correct answer is D.
Option “A” - Home equity would not provide a source of income. Option “B” - The value of the home is an asset, but this has nothing to do with cash flow statements. Option “C” - Taxes on his salary are an expense. Liabilities are shown on the state of financial position, not the cash flow statement
Which one of the following actions might the Federal Reserve take when using open market operations to regulate the supply of money and the availability of credit?
- Raise or lower the discount rate that influences market purchases and sales of fixed-income securities.
- Call high-coupon Treasury bonds and allow investors to purchase newly issued Treasury bonds with lower coupons.
- “Put” corporate bonds owned by the Fed to the issuing corporation to reduce the quantity of money in the hands of businesses.
- Purchase Treasury bonds from bank investment departments.
Solution: The correct answer is D.
The tools of the Federal Reserve include changing the discount rate, changing reserve requirements, and open market operations (which consist of either buying or selling Treasury securities depending on the Federal Reserve’s desired objective). This question is asking specifically about the Federal Open Market actions, which eliminates option A, as that is not an action of the FOMC. The FOMC deals with buying and selling treasuries with banking institutions (not businesses or individual investors). That eliminates options B and C.
As a direct result of a prolonged bull market and rising economy, the Chair of the Federal Reserve sees the possibility of problems looming on the horizon. Which of the following are among the issues the Chair may be anticipating, and what are the related actions might the Chair take to alleviate these circumstances?
- Stagnation; raise the Federal Reserve rate.
- Inflation; raise the Federal Reserve rate.
- Deflation; raise the required reserve.
- Recession; raise the opening bid at T-bill auctions.
- Irrational exuberance; print less money.
I only.
II only.
II and IV only.
III and V only.
Solution: The correct answer is B. - II only
The situation described presents a strong possibility of inflation. One way to control inflation is by raising interest rates. Raising required reserve is another, but it is incorrectly paired with deflation. The Federal Reserve does not print money, the Treasury Department does.
The primary function of the Federal Reserve System (central bank) is to:
- Implement fiscal policy.
- Carry out monetary policy.
- Issue bonds to the general public.
- Manage the revenues and expenditures of the federal government.
Solution: The correct answer is B.
The Federal Reserve controls the supply of money, enabling it to significantly impact interest rates. The Fed will follow a loose, or easy, monetary policy when it wants to increase the money supply to expand the level of income and employment. However, in times of inflation and when it wants to restrict the supply of money, the Fed follows a tight monetary policy.
Which of the following can the Federal Reserve do to reduce the money supply?
- Purchase Treasury securities.
- Decrease the reserve requirements for banks.
- Raise the discount rate.
I only.
II only.
III only.
I and III only.
Solution: The correct answer is C.
Only increasing the discount rate will reduce the money supply. Raising the discount rate will result in the bank keeping more on deposit to cover their reserve requirement, and lending less.
Purchasing Treasury securities from the banks (putting more cash into the banks) and decreasing the reserve requirements for banks will increase the money supply, as they will be able to lend more.
Which of the following can the Federal Reserve do to increase the money supply?
- Decrease the reserve requirements for banks from 8% to 6%.
- Increase expenditures of the federal government, thereby increasing the money supply in the economy.
- Conduct open-market transactions.
I only.
I and III only.
II only.
I and II only.
Solution: The correct answer is B. I and II Only
All of the above have the potential to increase the money supply; however, the Federal Reserve does not control the expenditures of the federal government. Increasing expenditures of the federal government would be fiscal policy, not monetary policy.
Which of the following are included among the tools available to the Federal Reserve (the Fed) to accomplish its responsibilities?
- Open market operations.
- Deficit spending.
- Discount rate change.
- Treasury bill issuance.
I and III only.
I, II and III only.
I, III and IV only.
I, II, III and IV.
Solution: The correct answer is A.
Choice “IV” - Issuing Treasury bills is the domain of the Treasury Department, not the Federal Reserve. Choice “II” - Deficit spending falls under fiscal policy which is governed by the executive and legislative branches of government, not the Federal Reserve.
Which of the following is not an integrating factor CFP Board will consider in determining if a CFP® professional has engaged in financial planning with a client?
- The number of relevant elements of the Client’s personal and financial circumstances that the Financial Advice may affect.
- The net worth and income of the client and how those may be affected by the Financial Advice.
- The length of time the Client’s personal and financial circumstances may be affected by the Financial Advice.
- The portion and amount of the Client’s Financial Assets that the Financial Advice may affect.
Solution: The correct answer is B.
A, C and D are integration factors provided by CFP Board’s Financial Planning and the Application of Practice Standards for The Financial Planning Process (4 a, b and c)
When you are establishing an engagement for financial planning with a client, what information may you provide orally?
- Material Conflicts of Interest
- Privacy Policy
- How the Client pays
- Terms of the engagement
Solution: The correct answer is A.
A planner may provide Material Conflicts of Interest orally or in writing.
B is incorrect because a planner must provide their privacy policy in writing.
C is incorrect because all types of compensation disclosures must be in writing for a financial planning engagement.
D is incorrect because terms of the engagement must be in writing
In which of the following situations is a CFP® professional not permitted by the CFP Board to use or disclose information related to a client or the client’s affairs?
- Within the CFP® professionals firm or to other persons with whom the CFP® professional is providing services with to clients.
- To the compliance officer of a broker/dealer where the client’s accounts were held in the past.
- As necessary to support or defend a civil claim made by a client.
- As necessary to provide information between attorneys, accountants and auditors.
Solution: The correct answer is B.
All other situations are authorized by duties owed to clients (9) Confidentiality and Privacy. The compliance officer where an account was held in the past does not have the authority to compel a CFP® professional to provide confidential information
Which of the following are exceptions under the definition of “investment advisor”?
- Banks that are NOT investment companies.
- Accountants or lawyers whose investment advice is “solely incidental” to the practice of their profession.
- Persons whose advice relates only to securities issued or guaranteed by the U.S. government.
- Publishers of financial publications that have regular and general circulation
Solution: The correct answer is D.
Exceptions do not come under the jurisdiction of the Investment Advisor’s Act and need not register as investment advisors
Which of the following is/are true regarding registering as an investment adviser?
- No one is exempt from the fraud provisions in the Uniform Securities Act.
- Accountants do not need to register under the Investment Advisers Act of 1940.
- Bank holding companies must register under the Investment Advisers Act of 1940.
- Brokers with more than 2 clients in a neighboring state must register in that state.
A only.
A and B only.
B and C only.
B and D only
Solution: The correct answer is A and B Only.
Lawyers, Accountants, Teachers and Engineers (LATE) do not need to register as investment advisers.
Banks do not need to register.
You can have less than 5 clients outside your state and not need to register.
Even if an exemption is available, they do not get out of the Anti-fraud regulations
Which of the following is an exemption from registration status of the Investment Advisers Act of 1940?
- Banks and bank holding companies that are not investment companies.
- Lawyers, accountants and teachers whose advice is solely incidental to the practice of their profession.
- Advisers whose advice and services is related to strictly to securities which are obligations of the U.S. government.
- Advisors whose only clients are insurance companies
Solution: The correct answer is D.
The parties in Option “D” are exemptions, but must abide by Section 206 of the Act (the anti-fraud provision.) All of the other answers are exceptions; that is, they need not register at all, and are not governed by the Act.
Federal authorities govern or influence the insurance industry in the following manner:
- The federal government NEVER influences insurance regulations. That is left to the individual states.
- Through the Internal Revenue Codes.
- Through the Securities Exchange Commission.
- Through the Employees Retirement Income Securities Act.
I only.
II, III and IV only,
III and IV only
II and IV only
Solution: The correct answer is B. II III and IV.
Insurance is regulated by the states from the prospective of what policies can be issued in a particular state, what companies can do business in a particular state. Keep in mind, if an insurance company wants to offer tax benefits, retirement benefits, or variable investments, other governing bodies will be involved.
Federal authorities govern the insurance industry in the following instances and manner:
I. is false if the insurance companies want to offer any extra benefits, tax or otherwise.
II. If insurance policies want to keep the tax benefits, they must follow IRS Codes.
III. If the policy is a variable policy, the Securities Exchange Commission will govern the variable investments.
IV. If Insurance is offered as an employee benefit, the policy must abide by rules set by the Employees Retirement Income Securities Act
John, age 25, is a CFP® professional and is opening his own financial planning practice next week. John is concerned about minimizing his risk of loss of personal assets resulting from liability associated with his practice. What should John do to minimize his risk of loss of personal assets?
- John should follow CFP Board guidelines on acting as a fiduciary with a duty of care, loyalty and following client instructions.
- John should form a multi party LLC to insulate liability.
- John should purchase a general liability insurance policy and an errors and omissions policy.
- John should use a suitability standard when evaluating and recommending investment alternatives, and other financial planning advice, for clients
Solution: The correct answer A.
Acting as a fiduciary forces John to follow a process putting his client’s best interest first and integrating sound decision making in his practice.
Doing something to keep yourself out of trouble is proactive. Insurance is reactive. It only comes into play after there is a problem, it does not stop or prevent a problem from happening. Car insurance does not stop an accident, safe driving does. Insurance is there to indemnify.
Setting up a practice following a fiduciary standard and putting the clients best interest ahead of your own will keep you out of trouble. E&O should be purchased as a best practice for if something goes wrong. No one buys insurance with the thought it will go wrong, at least we hope not.
Being a fiduciary is a proactive solution to risk management. B, C and D are great answers, but reactive
Ross is employed as a loan officer at a local bank. Ross recently sat down and visited with his financial planner Julie, a CFP® professional. Ross was in need of cash and borrowed $9,500 from Julie. Based on Julie’s duties to her clients’ according to the Code of Ethics and Standards of Conduct:
- Julie is not in violation of her duties to clients because Ross is in the business of lending money.
- Julie is in violation of her duties to clients because a CFP® certificant must never lend money to a client.
- Julie is not in violation of her duties because she loaned Ross less than $10,000.
- Julie has violated her duties to her clients by making a loan to Ross
Solution: The correct answer is D.
A CFP® professional may not, directly or indirectly, borrow money from or lend money to a Client unless:
i. The Client is a member of the CFP® professional’s Family; or
ii. The lender is a business organization or legal entity in the business of lending money.
Ross is not a bank (making A incorrect). B is incorrect Julie can lend in some circumstances and C is incorrect.
How does the CFP Board define a material conflict of interest?
- A conflict that requires the CFP® to enter mediation or arbitration with their employer.
- A conflict that could impact advice given by the CFP® professional or cause potential harm.
- A conflict that is apparent to the client.
- A conflict that will last through the planning relationship
Solution: The correct answer is B.
Duties owed to clients (5 a) defines material conflicts as ones that could impact advice or cause harm
The CFP Board’s definition of “more than any de minimis benefit tied to the sale of a financial asset” describes which of the following?
- Fee-only
- Sales related compensation
- Performance-based fee
- Affiliated fee and commission
Solution: The correct answer is B.
Sales Based Compensation is defined more than any de minimis benefit tied to the sale of a financial asset. Specific examples include bonuses, front end or trailing commissions, ongoing 12b-1 fees, transaction fees, revenue sharing or solicitor fees
A principal in your financial planning office, who is a CFP® professional, has been tried and convicted of securities fraud and malfeasance of funds by virtue of the fact that he commingled client funds with funds of the financial planning firm and with his own funds, as well. The CFP Board Code of Ethics prohibits a CFP® professional from doing such. As a result, which of the following is the CFP Board likely to undertake?
- Private censure.
- Public letter of admonition.
- Revocation.
- Temporary suspension of right to use the marks (up to 5 years).
- The CFP Board has no jurisdiction in this case, as it is a matter for the SEC to determine
Solution: The correct answer is C.
The Board could use suspension, but since it seems to be an offense that has been ongoing, and not an error or misjudgment, it is far more likely to go with the revocation in this case. The Board does have jurisdiction over its own, and the other options are simply too light for the level of offense
When does a material conflict of interest exist for CFP® professionals?
- When it could cause harm or impact potential advice
- When it causes a material change in the scope of a client relationship
- When it requires that the services of another professional be included in a client engagement
- When it causes a material disagreement between the CFP® professional and the client
Solution: The correct answer is A.
Duties owed to clients (5 a) defines material conflicts as ones that could impact advice or cause harm
Ethics in planning can be used for each of the following, EXCEPT:
- Establishing standards by which conduct can be measured.
- Forcing a uniform method of conducting business on professionals.
- Balancing the power of knowledge of the professional with the rights of the client.
- Providing a practical guideline for practice standards
Solution: The correct answer is B.
Practical ethics leaves much latitude for practicing the profession of financial planning
The husband of one of your clients had his wallet stolen. He had five credit cards in his wallet when this occurred. He reported the cards as missing the next morning, but the following transactions had already occurred: (Discover Card - $350) (MasterCard - $100) (VISA - $425) (Sears - $25) (Marshall Fields - $685) What is the client’s liability for the fraudulent transactions on these cards?
- $50
- $225
- $250
- $1,235
Solution: The correct answer is B.
The maximum on any missing card that the client would have to pay would be $50. But remember the thief only charged $25 on the Sears Card. Therefore, the total is 4 cards times $50 plus $25, which equals $225.
The rules are different when the card number, not the card, is stolen
Regulation Z, issued by the Federal Reserve Board, is a part of the Consumer Credit Protection Act. Regulation Z requires that:
- Lenders must disclose the items purchased.
- Lenders must be given a “cooling off” period.
- The dollar amount of finance charges and the annual percentage rate be disclosed.
- The length of time to pay the debt be disclosed
Solution: The correct answer is C.
With the advent of Regulation Z, consumers were able to see the actual cost (including finance changes) that they were paying in any transaction they were making
Workers’ compensation is a federally and state mandated program which provides benefits for:
- Unemployed workers.
- Workers suffering injury or illness on the job.
- All injuries and illnesses workers contract.
- Inability to continue work
Solution: The correct answer is B.
Employers bear the cost of the workers’ compensation programs whose rates are based on merit (previously claim experience). Thus, the incentive is provided to reduce on-the-job accidents
Mrs. Hoffman is an 80-year old widow whose liquid assets are on deposit at a small FDIC-insured bank. She has the following on deposit: - $75,000 in various Certificates of Deposit - $50,000 in a Money Market Mutual Fund - $200,000 in an IRA Rollover - $25,000 Passbook Savings (Joint with son) - $25,000 Checking Account (Joint with daughter) How much is currently insured by the FDIC?
- $100,000
- $125,000
- $250,000
- $375,000
Solution: The correct answer is B.
The $75,000 CDs are insured under Mrs. Hoffman (Single). The $50,000 Money Market Mutual Fund is not insured by the FDIC. It may be insured under the SIPC but that is not what the question is asking. The $200,000 could be insured but we do not know what the IRA is invested in as it must be cash to receive FDIC coverage. The Passbook Savings is FDIC insured jointly with her son ($12,500 for each Mrs. Hoffmann and her son) for a total of $25,000 coverage. The Checking account is FDIC insured jointly with her daughter ($12,500 for each Mrs. Hoffmann and her daughter) for a total of $25,000 coverage.
In Summary:
$75,000 in various Certificates of Deposit – Covered by FDIC
$50,000 in a Money Market Mutual Fund – Not Covered
$200,000 in an IRA Rollover – We don’t know if it would be covered. No investment was stated, do not assume.
$25,000 Passbook Savings (Joint with son) – Covered
$25,000 Checking Account (Joint with daughter) Covered
TOTAL FDIC COVERAGE: 125,000
The question asked “How much is currently insured by FDIC”, NOT what Mrs. Hoffman was covered for. IF the question had asked “How much is Mrs. Hoffman insured for under the FDIC?” the answer would be: $75,000 + $12,500 + $12,500 = $100,000, due to the joint accounts with her children
If the maximum loan-to-value ratio on a $100,000 home is 80%, this means that the lender would accept:
- A minimum down payment of $20,000 plus closing costs.
- A minimum down payment including closing costs of $20,000.
- Closing costs plus points of $20,000.
- A maximum down payment of $20,000
Solution: The correct answer is A.
Closing costs are not included in the loan-to-value ratio calculations of the lender. Closing costs are in additional to the minimum down payment
If the demand for a product is inelastic, it means that:
- An increase in the price would lead to an increase in the total amount spent on purchases of the product.
- An increase in the price would lead to a decrease in the total amount spent on purchases of the product.
- An increase in the price would have no effect on the total amount spent on purchases of the product.
- The demand and supply are in equilibrium
Solution: The correct answer is A.
Choice “B” is the description of a product whose demand is elastic. Choice “C” describes the demand of a product that is perfectly elastic. Choice “D” is a description of the equilibrium point in supply and demand.
For example:
If demand is 100 units and the price is $5, then total spent on the product is 100 × $5 = $500.
If price is increased to $7 and demand is still 100 units (inelastic = qty. demanded does not change when price changes), then total spent is 100 × $7 = $700
Consumer demand for sugar at $.80 per pound results in $1,000 in company revenue, and a drop in price to $.50 per pound results in $1,250 in revenue. Which of the following may be concluded about demand for sugar?
- It is unit elastic.
- It is inelastic.
- It would overtake supply.
- It is highly elastic
Solution: The correct answer is D.
Elasticity indicates a lower price will increase overall revenues
