Question 1 [20 marks]

What is false in the following reasoning?

"The use of language in economics can be very confusing because the economic logic itself is subtle. A case in point is profit maximization and cost minimization. One cannot exist without the other. We all know that profit maximization implies cost minimization. What may not be as obvious is that cost minimization also implies profit maximization. This explains why economists' advice to the real world managers that they should be concerned only with cost minimization if they want to maximize profits."

Please note carefully this question is about what is false, not about what is correct.

Part A. Clear identification of what is false in the reasoning [10 marks]

Part B. Justification of choice of sentences in Part A [10 marks]

Question 2 [20 marks]

This question refers to a hypothetical social drinker -called Carlota- who goes to a pub every evening. It is assumed that she is willing to select her weekly consumption of two products beer ( ) and wine ( ) so as to maximize her satisfaction.

Carlota has not been able to describe her utility function U =U(x,y) with a specific formula, but after carefully introspection, she has been able to draw three indifference curves (shown in Figure 1) on which to base her choice of (number of glasses of beer per week) and (number of glasses of wine per week).

Carlota needs to sort out what happens with her satisfaction in two different situations.

Situation 1

Last week Carlota spent $100.00on social drinking in a North Wollongong pub where she paid $4.00for each glass of beer and $8.00 for each glass of wine.

Situation 2

This Monday, Carlota found another pub in the North Beach where one glass of beer cost $2.00and one glass of wine $4.00 . She is planning to take advantage of this finding and reduce her spending on social drinking to just $50.00per week, even though this could reduce her maximum level of satisfaction.

Part A [10 marks]

What is the solution to her optimization problem in Situation 1? [2 marks]

Explain carefully. [8 marks]

Part B [10 marks]

What is the maximum level of satisfaction she would reach in Situation 2? [2 marks] Explain carefully. [8 marks]

Please note: precision in your answers is required to receive full marks.