Profit (Unit-V)
Schumpeter’s
Innovation Theory
(ECB-601 FP and WE, Sem-VI)
Dr. HARI RAM PRAJAPATI
Assistant Professor, Economic section,
MMV, BHU, Varanasi
Topic
-Introduction
-Schumpeter’s Innovation Theory
-Criticism
Introduction
– The Innovation Theory of Profit was proposed by Joseph. A.
Schumpeter, who believed that an entrepreneur could earn
economic profits by introducing successful innovations.
– In other words, innovation theory of profit posits that the main
function of an entrepreneur is to introduce innovations and the
profit in the form of reward is given for his performance.
Schumpeter’s Innovation Theory
– According to Schumpeter, innovation refers to any new policy that
an entrepreneur undertakes to reduce the overall cost of
production or increase the demand for his products.
– Thus, innovation can be classified into two categories;
– The first category includes all those activities which reduce the
overall cost of production such as the introduction of a new method
or technique of production, the introduction of new machinery,
innovative methods of organizing the industry, etc.
Contd.
– The second category of innovation includes all such activities
which increase the demand for a product, such as the introduction
of a new commodity or new quality goods, the emergence or
opening of a new market, finding new sources of raw material, a
new variety or a design of the product, etc.
– The innovation theory of profit posits that the entrepreneur gains
profit if his innovation is successful either in reducing the overall
cost of production or increasing the demand for his product.
Contd.
– Often, the profits earned are for a shorter duration as the
competitors imitate the innovation, thereby ceasing the innovation
to be new or novice.
– Earlier, the entrepreneur was enjoying a monopoly position in the
market as innovation was confined to himself and was earning
larger profits.
– But after some time, with the others imitating the innovation, the
profits started disappearing.
Contd.
– An entrepreneur can earn larger profits for a longer duration if the law allows
him to patent his innovation.
– Such as a design of a product is patented to discourage others to imitate it.
– Over the time, the supply of factors remaining the same, the factor prices tend to
rise as a result of which the cost of production also increases.
– On the other hand, with the firms adopting innovations the supply of goods and
services increases and their prices fall.
– Thus, on one hand the output per unit cost increases while on the other hand
the per unit revenue decreases.
Criticism of Innovation Theory
– The innovation theory of profits has been criticized on the
following grounds;
1. It ignores the element of uncertainty.
2. In addition to innovations, there are many other factors which give
rise to profits.
3. In modern enterprises, it is the entrepreneur who bears the risk,
not the capitalist as Professor Schumpeter believes.
Contd.
– The innovation theory does not take into consideration the element
of uncertainty as an important factor giving rise to profits. As
pointed by Prof. Knight the main emphasis should be placed on
uncertainty and not on innovation because even in absence of
innovations, the entrepreneur would be able to earn profits if he can
predict the future with a fair degree of certainty in so far as the
changes in the demand and supply conditions are concerned.
– Besides innovations, there are several other factors which give rise
to profits, for e.g.- existence of monopoly, chance profits etc.
Contd.
– The theory also does not consider profits as the reward for risk taking.
According to Prof. Schumpeter, "The entrepreneur is never the risk-
bearer. The one who gives credit comes to grief if the undertaking
fails." This, however, is not correct, for we know that in the modern
industrial organization, it is the entrepreneur and not the capitalist who
bears the entire risk of business.
– Lastly, it has also been said that the function of the entrepreneur is not
only to introduce innovations but also to organise the business in the most
efficient manner by co-ordinating the activities of the various factors of
production. As such, profits are not exclusively due to innovations but also
due to the superior organisational ability of the entrepreneur.
Thanks
