Theories of Entrepreneurship

Unit II

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Theories of EntrepreneurshipInnovation Theory by

Schumpeter and ImitatingTheory of High Achievement by

McClelland X- Efficiency Theory by

LeibensteinTheory of profit by KnightTheory of social change by

Everett Hagen

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Theories of EntrepreneurshipComplex concept

◦Economical, sociological, political, psychological, ethical, religious, cultural values

◦Comprehensive theory is yet to come

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Innovation Theory by Schumpeter

Joseph Schumpeter (1934)

Acco. To him, process of innovation in entrepreneurship may be in the form of-◦Introduction of new product◦Use of new method of production◦Opening of new market◦Conquest of new source of supplying raw

material◦New form of organization

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Entrepreneurship is innovation!

Entrepreneur brings innovative and technological changes in society

Entrepreneur brings newness in everything

Entrepreneur is the catalyst that disturbs the stationary circular flow of the economy and thereby initiates and sustains the process of development

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Continued..Innovation in the form of

◦new ideas, ◦new products, ◦new methods/ functions, ◦opening new market, ◦capture of new source of raw materials,◦carrying out new organization

Schumpeter’s concept of innovation includes element of risk taking, coordination, risk talking

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Continued..However, if innovation is absent, presence

of rest of the elements cannot make E’reE’ship is an initiative taken to go beyond

the existing way of lifeBut, there is a difference between Inventor

and InnovatorCriticism:

◦This theory assumes existence of capitalist society, with private property, private initiative, money and banking system, etc.

◦Applicability and success of this theory becomes doubtful in under developed country

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Theory of High Achievement by McClelland

David McClelland’s Achievement Motivation Theory

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nAchIt’s a drive to excelNeed for success and to achieve in

relation to a set of standardsPeople with high need for achievement

behave in entrepreneurial wayEntrepreneurs become link between need

achievement and economic growthHigh (nAch)- more likely to succeed as

entrepreneursAmbitions is the level of all motives…it

differs from greed and windfall

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Levels of need for achievement varies with society to society…country to country

McClelland’s Thematic Appreciation Test (TAT)◦ Need for achievement promotes economical

growth◦ Induced achievement motivation can provide

them with urge to improve their lot◦ It can help break barrier of ‘limited aspirations’◦ He conducted experiments in America, Mexico

and India.. And full fledged program in Kakinada University (AP)

◦ Program was conducted at Extension Training Instt., AP

◦ Training was given to 52 persons grouped in 3 batches

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Training was designed primarily to stimulate the imagination and encourage introspection into personal motivation and community goals. The individuals strived to attain concrete

and frequent feedbackThe participants sought models of

achievement, i.e. Watched those who have performed well and tried to emulate/ imitate

The participants imagined themselves in need of success and challenge and set carefully planned and realistic work goals

The trainees were asked to control day dreaming by thinking and talking to themselves in positive terms

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Leibenstein’s X-Efficiency TheoryHarvey Leibenstein (1922-1994)

The concept of x-efficiency was introduced by Harvey Leibenstein in his paper Allocative efficiency v. "x-efficiency" in American Economic Review 1966

X-Efficiency is the degree of inefficiency in the use of resources within the firm: it measures the extent to which the firm fails to realise its productive potential

His research is motivated from observation of variance in degree of effort….efficiency varied! This encouraged Leibenstein to research about effort and efficiency

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In economics, technical-efficiency is the effectiveness with which a given set of inputs is used to produce an output. If a firm is producing the maximum output it can, given the resources it employs, such as labor and machinery, and the best technology available, it is said to be technically-efficient.

X-inefficiency occurs when technical-efficiency is not being achieved due to a lack of competitive pressure. The concepts of x-inefficiency and x-efficiency were introduced by Harvey Leibenstein

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What is efficiency? How is efficiency gained?◦Working systematically, methodically◦Continuous and efficient supply of

resources◦Avoid underutilization or wastage of

resources◦Planning work◦Delegation of work according to skills,

attitudes◦Standardization of routine work/ tasks◦Coordination◦Follow-up and feedback (controlling)

What is productive potential?◦ Use of resources◦ Effective of organization

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LEIBENSTIEN’S THEORY OF X-EFFICIENCY

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Acco. To Leibenstien :◦Routine Entrepreneurship◦New Entrepreneurship

Entrepreneur should always try to fill in the gap between existing knowledge and actual production function, visualizing the economy as a net made up of nodes and pathways

Efficiency= output/ input

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This theory had basic postulates like◦ imperfect markets, ◦ Incomplete◦ labor contracts◦ production function, ◦ discretionary effort, ◦ rationality as a continuum, ◦ and inert areas.

First, x-efficiency theory focused on imperfect markets caused by monopoly power or asymmetric information

Criticism: But, can we determine output of every input??

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Theory of Profit by KnightFrank Hyneman Knight (November 7, 1885 – April 15, 1972)

◦ American Economist & founder of Chicago School◦ Best known for his book ‘Risk uncertainty & profit’

According to Prof. Knight“Profit is the reward for uncertainty bearing and

not the risk bearing”.

Prof. Knight has regarded uncertainty bearing as a factor of production. Knight’s theory classifies the position that profit arises because of the joint action of uncertainty bearing and capital.

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Profit & ProfitsGenerally- Profits of firm mean the

actual net revenue that it has earned in some past period of time.

However, Knight distinguishes between ‘Profit’ and ‘Profits’◦Profit- expected net revenue in time

period ahead◦Profits- net revenue which a firm has

actually succeeded in earning during a period that has ended

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Profit and Profits..

Comparison of profit and profits tells us the extent to which a firm has succeeded/ erred

Negative profits= losses

Profit of newly set up enterprises if to be compared with existing firms……

Assumption of perfect competition

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Risk and Uncertainty

Generally…risk refers to outcomes that can be insured against, and uncertainty to outcomes that cannot be insured against

Knight interprets Risk and Uncertainty in a diff. manner◦ Risk- conditions in which profit cannot

exist..future is subject to risk◦ Risk is insurable◦ Uncertainty- conditions in which profit may

exist…future is uncertain.◦ Uncertainty is uninsurable

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In this theory he claims that bearing uncertainty is the least important of the entrepreneurial functions, and that introducing innovation and adapting to the innovation of others are more important.

From this second theory the incentive for entrepreneurial action is clear, the entrepreneur introducing innovation is able to act as a monopolist and earn monopoly profits.

Those who respond most quickly to the innovation earn some profits. Eventually a sufficient number of entrepreneurs will have entered the market and profits from the innovation will be reduced to zero.

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If new firms were banned from entry in market, the ‘profit’ of existing firms would be high..due to less competition

Legal barriers, immobility of resources, indivisibility, lack of knowledge and lack of foresight…how these factors affect entrepreneur’s profit

Profits are absent in the state of perfect competition because each entrepreneur has equal opportunities and equal capacities

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The presence of profits in the long –run therefore means that diff. entrepreneurs are aware of diff. opportunities and that their abilities to exploit the opportunities that are open to them are diff. also.

Why these differences arise then?

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These differences arise because-a) Entrepreneurs already established

in an industry may be protected by law or by (other) barriers that they themselves have created

b) Entrepreneurs already there may be ‘protected’ by ‘indivisibilities’ of plant and resources and

c) Entrepreneurs do not feel equal uncertainty about the future and are not equally willing to live in the presence of uncertainty

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The uncertainty mentioned in (a) and (b) is called economic rent and uncertainty mentioned in (c ) is called pure profits.