The economic theory of entrepreneurship firmly states that the economy and entrepreneurial activity are intertwined, with entrepreneurs needing prosperous conditions to be able to thrive. In other words, if an economy is doing well then positive outcomes in terms of business growth can follow; conversely, a poor-performing economy equates to limited opportunities for businesses.
Economic factors play an important role in the development of entrepreneurial activities. Economic theories such as achievement motivation, innovation theory, and entrepreneurship development are all related to economic conditions that can affect how entrepreneurs behave. Economic influences combine with social and cultural contexts to shape how successful an entrepreneur can be.
This concept asserts that entrepreneurs are motivated by economic incentives such as technological market knowledge and associated resources. Furthermore, these motivating factors may include access to infrastructure, industrial policy options, taxation policies, and relocation trends all while keeping in mind potential investment opportunities or marketing openings.
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What is the Economic theory of Entrepreneurship?
The economic theory of entrepreneurship is a theory that explores the relationship between economic conditions and entrepreneurial activity. It states that when an economy is doing well, there are more opportunities for businesses to succeed, while a poor-performing economy limits the opportunities for businesses.
Proponents of this theory highlight economic incentives as the major motivating factor for individuals to become entrepreneurs, believing that it is these rewards that drive them to execute all activities. The profit motive forms the basis of this argument, demonstrating its crucial role in transforming an individual into a successful entrepreneur.
In J.R. Harris and G.F Papanek’s view-
The inner drive of a man is associated with economic gains, which drive him into economic activities. Therefore, they regard economic gains as a pre-condition for the supply of entrepreneurs.
In the words of Kirzner-
A typical entrepreneur is the arbitras, the person who discovers opportunities, the person who discovers opportunities at low prices and sells the same at high prices because of intertemporary and inter- partial demand.
This theory focuses primarily on economic gains and rewards which create an entrepreneurial class within society.
Economic Theories of Entrepreneurship
Economic growth and entrepreneurship have been linked to the presence of favorable economic conditions. Entrepreneurs play a fundamental role in stimulating economic development, which is defined as an increase in real national income over time.
Entrepreneurial activities are primarily driven by economic incentives – taxation policy, industrial policy, financing, raw material sources, infrastructure accessibilities, investment prospects, and marketing chances to gain insight into market trends along with technological advances. All of these motivators help foster an environment conducive to entrepreneurs. Let’s have a look at different theories that are part of the economic theory of entrepreneurship-
1. Theory of Functional Behaviour
Mark Christopher Casson’s theories of entrepreneurship offer an integrated view of how the business firm works and functions.
His research delves into the functional behavior of entrepreneurs and identifies qualities necessary for their success. By analyzing his work, one can gain a better understanding of what it takes to be successful in this field.
By tapping into an institutional approach to entrepreneurship, the strategic problems of organizations can be more effectively deciphered and consolidated. An environmental shock yields four distinct dimensions that bring about various kinds of entrepreneurial activities, thus forming businesses with distinct sizes and structures.
Entrepreneurs build companies that identify and keep track of sources of volatility, sharing this data with the key decision makers in their company.
These businesses are situated at places where a lot of information flows through, such as nodes on an informational network.
To adapt to an unpredictable world full of instability and varied access to knowledge, the classical economic theory is modified by taking into account how different people may interpret their industry differently because they have differing levels of insight.
2. Theory of Economic Incentives
G.F.Papanek and J.R Harris’s Theory proclaims that financial incentives are the main factors driving entrepreneurial ventures forward – featuring elements such as:
Economic incentives: Economic incentives offer an advantage to those who take risks and innovate. Economic incentives can be monetary or non-monetary such as the right to earn creative benefits, recognition of efforts, or even tax exemptions.
A Link between economic gains and the inner urge: Economic incentives are often linked to personal desires and motivations. Economic gains can be used as a means of achievement, generating pride, self-esteem, and recognition among peers.
Economic gain: Economic gain provides the motivation to overcome challenges present in the entrepreneurial venture by creating an environment where people are provided with the right resources to excel in their respective industries. The economic gain from an entrepreneurial venture also creates a sense of economic security and a path for further development.
3. Theory of Adjustment of Price
M. Kirzner posits that the primary responsibility of entrepreneurs is to adjust prices in markets accordingly.
For both the buyer and seller, higher or lower prices present opportunities for profit. Moreover, any difference in pricing across various markets can be capitalized on through arbitrage that offers a lucrative outcome.
Adjusting the prices of commodities based on demand and supply helps entrepreneurs to earn a profit. As such, the entrepreneur has to be constantly aware of the fluctuations in market conditions and use this knowledge to adjust prices, when necessary.
The theory of adjustment of price also suggests that entrepreneurs should be active in the market and be on the lookout for any discrepancies that could result in a profit.
4. Theory of X-Efficiency
Harvey Leibenstein’s Gap Filling Theory, or X-efficiency Theory as it is commonly known, has become a highly acclaimed concept.
Leibenstein proposes that entrepreneurial activities are determined by X-efficiency, which indicates how inefficient resources within the company are utilized.
This includes the common tasks of an entrepreneur, such as starting new businesses, juggling multiple roles and responsibilities, plugging up gaps in resources or knowledge, completing inputs for a project’s success, and making sure that productivity is at its peak.
X-efficiency theory states that the entrepreneur needs to be keenly aware of their organization’s X-efficiency and take measures to increase or maintain it. The theory also emphasizes how entrepreneurs should take advantage of external resources and make sure that their business is utilizing its resources efficiently. This results in improved productivity increased profits and a more successful venture.
5. Theory of Innovation
Joseph Schumpeter is the mastermind behind this revolutionary theory which holds that entrepreneurs are instrumental in driving economic growth.
His groundbreaking work on entrepreneurship has been a source of inspiration for countless economists and business professionals alike. This extraordinary concept spawned an entirely new field of research focused on how entrepreneurs can be leveraged to drive economic development.
Schumpeter’s definition of entrepreneurship is that it involves the creative art of transforming and combining elements in new ways.
An entrepreneur, he claims, must possess creativity, innovation abilities, and foresight to identify business opportunities for development. In short – a successful entrepreneur needs to be imaginative with their vision!
Schumpeter’s theory stresses the importance of innovation, which overlooks the daringness and managerial aptitudes of an entrepreneur. Schumpeter’s idea of an entrepreneur is a giant businessperson, who virtually never exists in emerging countries where most entrepreneurs are small-scale businessmen that require imitation more than invention.
Consequently, the Schumpeterian theory of entrepreneurship is characterized by the following features:
- The distinction between invention and innovation: Schumpeter proposed that invention is the creation of something totally new, while innovation refers to the process of utilizing the invention.
- Emphasis on entrepreneurial function: Schumpeter argued that entrepreneurs have an important role to play in the process of innovation, as they are the people who recognize potential opportunities and make decisions based on them.
- Presentation of disequilibrium situation through entrepreneurial activity: According to Schumpeter, entrepreneurial activities are characterized by a certain degree of instability or disequilibrium. This is due to the fact that entrepreneurs are constantly looking for new ways to create something which can be sold at a profit.
6. Theory of Harvard School
Harvard University’s research revealed that entrepreneurship is the intentional effort to start, manage, and grow a profit-making enterprise with economic goods or services in spite of any conflicting internal and external pressures.
Internal forces are the personal traits within us such as intelligence, capability, expertise, sensibility, outlooks, and other abilities that can help shape our decisions.
Internal and external forces profoundly shape an individual’s capacity to engage in entrepreneurial endeavors. Internal triggers include the motivation, skills, knowledge, confidence, and resources of a person; whereas external pressures refer to economical, social-cultural, and political-legal dynamics that can foster or impede entrepreneurship within any given society.
According to this theory, there are two primary forms of entrepreneurial activities:
- The ability to organize and combine resources for the purpose of creating successful businesses is an essential entrepreneurial skill
- Decision-making processes are significantly impacted by the environment and its responsiveness. Additionally, these functions extend to other activities mentioned previously
7. Theory of High Achievement
David McClelland’s theory has been developed over time to help us better understand the motivation.
He expressed that entrepreneurship can be defined by the presence of two primary characteristics revolutionizing the status quo with innovative solutions and navigating challenging and unpredictable scenarios with decision-making.
He emphasized that those with a strong drive to succeed are the most likely individuals to become entrepreneurs. These people strive for success and do not let external factors, such as money or incentives, sway them. To them, profit is an indication of competence and achievement.
According to McClelland, individuals have a trio of needs that must be fulfilled at any moment such as-
- Achieving success through one’s own hard work and dedication is known as the Need for Achievement
- The urge to control and influence others is a powerful one
- Developing and preserving friendly relationships with others is an essential need
8. Theory of Profit
Knight, Frank H. developed this theory which emphasizes that entrepreneurs are a specialized group of people who endure risk and manage uncertainty.
This concept is unique in its ability to guarantee a predetermined amount of profit, while also addressing the underlying socioeconomic and psychological factors that can create uncertainty or risk. It then employs consolidation techniques to ensure any associated business risks are minimized.
In essence, the Economic Theory of Entrepreneurship relies on a combination of analytical knowledge and intuition to make informed decisions. It encourages entrepreneurs to use their experience and insight to navigate the challenging and unpredictable world of business.
9. Theory of Market Equilibrium
Hayek argues that the Neo-classical economics model relies heavily on the assumption of market equilibrium, thereby eliminating any role for entrepreneurs from its analysis.
The fluctuating nature of bank credit creates a gap between the natural and market rate of interest. This hypothesis suggests that there is no need for extra details to alter our decision-making process.
Instead, it is the entrepreneurs who are in charge of making decisions related to market trends and ensuring that their business is profitable. Hayek’s Economic Theory of Entrepreneurship suggests that entrepreneurs are the ones with the most knowledge, experience, and insight to make decisions based on market trends.
Economic Factors affecting Economic Theory of Entrepreneurship
Economic theory is a way of looking at how economies work. It can be used to explain why entrepreneurs choose certain businesses and the resources they need to make them successful. It suggests that entrepreneurial development depends on the demand structure, resources available, and an individual’s ability to access these resources.
Economic theory also looks at how incentives, such as taxes and government regulations, affect entrepreneurs. The Economic Theory of Entrepreneurship (ETE) is based on the idea that entrepreneurs are motivated by economic incentives, rather than just their entrepreneurial personality.
This means that there must be a strong incentive for entrepreneurs to pursue a business venture, such as access to capital, favorable government regulations, or a new market opportunity.
Religious beliefs also have a significant influence on the actions of entrepreneurs and the way they operate in a given environment. For example, sects or religions which promote individualism and the pursuit of success may result in inspired entrepreneurs creating new businesses.
The status withdrawal theory is another sociological theory that suggests that some individuals may become entrepreneurs when they feel their social standing has decreased within their existing circle of friends. Sociological theories explain the links between social structures and entrepreneurial activities.
Psychological theories offer another view on entrepreneurial development. The psychological theory suggests that entrepreneurs possess superior levels of certain personality traits, such as creativity and risk-taking, that enable them to become successful in their endeavors.
Additionally, the psychoanalytic theory suggests that entrepreneurs are attracted to self-employment due to a lingering desire to escape from authority figures. Entrepreneurs require resources, structure, and a demand for their goods or services in order to become successful. Economic theory suggests that entrepreneurial activity is driven by potential profits, which may be seen as a motivation factor for entrepreneurs.
Conclusion!
The Economic Theory of Entrepreneurship asserts that entrepreneurs are driven by economic rewards and that there are certain incentives and opportunities that can be used to encourage more entrepreneurial activity.
By understanding this theory, businesses have the opportunity to structure the environment in which they operate to better incentivize and encourage entrepreneurship. This could mean implementing policies that reduce risk, provide more attractive financial incentives, or give entrepreneurs access to mentorship and resources.
What according to you is the most important takeaway from the Economic Theory of Entrepreneurship? Share your thoughts in the comments below!
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