1. Theories of Entrepreneurship
Unit II

2. Theories of Entrepreneurship
Innovation Theory by Schumpeter and
Imitating
Theory of High Achievement by
McClelland
X- Efficiency Theory by Leibenstein
Theory of profit by Knight
Theory of social change by Everett
Hagen
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3. Theories of Entrepreneurship
Complex concept
◦ Economical, sociological, political,
psychological, ethical, religious,
cultural values
◦ Comprehensive theory is yet to
come
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4. 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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5. 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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6. 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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7. Continued..
However, if innovation is absent, presence
of rest of the elements cannot make E’re
E’ship is an initiative taken to go beyond
the existing way of life
But, there is a difference between Inventor
and Innovator
Criticism:
◦ 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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8. Theory of High Achievement by
McClelland
David McClelland’s Achievement
Motivation Theory
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9. nAch
It’s a drive to excel
Need for success and to achieve in relation
to a set of standards
People with high need for achievement
behave in entrepreneurial way
Entrepreneurs become link between need
achievement and economic growth
High (nAch)- more likely to succeed as
entrepreneurs
Ambitions is the level of all motives…it
differs from greed and windfall
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10. 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 10

11. 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 feedback
The 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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12. 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 12

13. 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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14. 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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15. 15
LEIBENSTIEN’STHEORYOF X-EFFICIENCY

16. 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
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Efficiency= output/ input

17. 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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18. Theory of Profit by Knight
Frank 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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19. Profit & Profits
Generally- 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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20. 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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21. 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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22. 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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23. 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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24. 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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25. 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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26. The uncertainty mentioned in (a) and
(b) is called economic rent and
uncertainty mentioned in (c ) is called
pure profits.
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