The Convergence of Utility and Profit Maximization

Abstract

The literature discussing conditions leading to convergence of utility and profit maximization for owner-controlled firms has a long history. Scitovsky initiated discussion and derived important result that, in short run, utility and profit maximization are necessarily equivalent only when the several indifference of owner are displacements of each [10, 59]. Hereafter, we refer to indifference curves that are vertical displacements of each other as Scitovsky condition.' Ladd [6] restates Scitovsky's model in mathematical form and reaches same conclusion. Piron [8] extends Scitovsky's analysis to long run and concludes that utility maximizers also maximize profit. Recent contributions to literature examine issue of convergence when entrepreneur receives nonpecuniary benefits from managing firm. Olsen [7] concludes that a utility maximizer who derives benefits from being self-employed does not necessarily maximize profit in either short or long run. Feinberg [2; 3; 4] and Schlesinger [9] conclude that utility and profit maximization necessarily diverge when nonpecuniary benefits cannot be obtained outside firm. In contrast, Hannan [5] argues that utility and profit maximization necessarily converge even when nonpecuniary benefits exist. A theoretically precise measure of opportunity cost of entrepreneurial activity is crucial to this discussion. Profit is total revenue less all opportunity costs of production, including entrepreneurial activity. A theoretically precise measure of opportunity cost of such activity is, therefore, a prerequisite for a precise measure of profit. Scitovsky uses indifference curve passing through point indicating choice of total leisure to gauge opportunity cost. Ladd and Piron follow Scitovsky's procedure. Olsen, Feinberg, and Schlesinger (hereafter OFS) use wage rate foregone as indicator of opportunity cost.