Virtual Prices and a General Theory of the Owner Operated Firm

Abstract

Theories of entrepreneurial behavior for owner operated firms have a long history in economics. These models treat the owner operator as both a producer and consumer of goods. Production and consumption choices result from utility maximization. A preponderance of the work performed in this area has addressed two theoretical issues, the consistency of utility and profit maximization and comparative static behavior of the entrepreneur. Scitovszky's seminal paper [29] demonstrates that under certain circumstances the entrepreneur may trade-off income for leisure giving rise to the possibility of income effects on production and inconsistency of utility and profit maximization. Building on Scitovszky's work, Graaff [14], Clower [6], Auster and Silver [3], and Lapan and Brown [18], analyze the comparative static behavior of the utility-maximizing owner operator and how this differs from the traditional neoclassical profit-maximizing firm. Emphasis is on the possibility of income effects on production and how they may result in seemingly uneconomic behavior. A shortcoming of this literature is the focus on special cases based on strong restrictions on technology (constant returns to scale) and the market for the entrepreneurial input (no such market exists). As of yet, a general analysis of the comparative static behavior of the entrepreneur has not been undertaken. Scitovszky's work also initiated a vigorous debate concerning the consistency of utility and profit maximization for owner operated firms. This debate centers on two principal questions. Does utility maximization imply profit maximization? If not, can a utility-maximizing owner operated firm survive through time? Piron [25], Olsen [23; 24], and Hannon [15] conclude that in competitive long-run equilibrium utility-maximizing entrepreneurs necessarily maximize profit and must do so to remain viable. Ladd [17], Auster and Silver [3], Feinberg [8; 9; 10], and Schlesinger [28] conclude that utility and profit maximization may diverge. Moreover, these writers maintain that non-profit-maximizing owner operated firms can survive through time. More re-