Question 1:
Explain and discuss the role (and definition) of the entrepreneur according to different economic theories.What is your view on entrepreneurship?
What is an entrepreneur? Is it a person who is born with the natural traits to be successful in business? Is it someone who takes advantage of a situation and takes risks for his or her own financial benefit? Is it the inventor who creates and produces the latest innovations? Or is it merely an individual able to allocate resources efficiently? Well the answer to this question is that the entrepreneur can be all and none of these at the same time, because the fact is that the definition of what and who an entrepreneur is has been debated for many years. Researchers and economists, still today, disagree on exactly what he or she is. What can be said though is that when reviewing the early views on entrepreneurship, it can be seen that there have been several perspectives on the subject. Four major definitions revolve each around the entrepreneur being:
– A risk taker;
– A resource allocator;
– An innovator; or,
– A naturally gifted individual (born-entrepreneur).
Interestingly, there seems to be some level of overlap from particular individuals, in regards to the four perspectives listed above. The opinions of significant researchers and economists have been categorised into these areas. First, let us explore those with perspective that the entrepreneur is a risk taker. This point of view was shared by Cantillon, Kirzner and Knight.
“An Entrepreneur is someone who bought at certain prices but sold at uncertain prices.”
– (Cantillion, 1755).
“An Entrepreneur is someone who calculates and takes risks and manages uncertainties.”
– (Knight, 1921).
First, in 1755, Richard Cantillon saw the entrepreneur as a person who conducted business, taking on calculated risks in each exchange or business deal, and in the process, aimed to capitalise. Cantillon expanded on this definition and went even further to suggest that any individual with an uncertain income could be labeled as an entrepreneur (PARKER). He believed that entrepreneurs stimulated production and business and enabled market equilibrium � part of neoclassical economic theory. Cantillons’ definition of an entrepreneur was far from that of an innovator. The individual instead was an intelligent, risk taker.
Israel Kirzner also saw the entrepreneur as somewhat of a middleman, aware of profitable opportunities and who took advantage of them with calculated risks. Kirzner stated that successful entrepreneurs profit only due to their exceptional alertness, which sets them apart from the rest of the crowd. Importantly though, it should be stated that Kirzner differed from Cantillon in regards to their backgrounds in economic theory. Kirzner was an Austrian, and in turn saw entrepreneurship as a driving force to push the market towards equilibrium through the correction of past business and economic errors, but which would never reach equilibrium.
Finally, Knights’ opinion was that entrepreneurs could not predict output prices and profits and due to an uncertainty in a range of different areas, they must take risks when conducting their business. Further, Knight believed that entrepreneurs needed to possess a few specific personal traits, including: self-confidence; daring personality; and insight, in order to fully take advantage of the opportunities in the market. Thus, he did not think that individuals were born to be entrepreneurs, or vice versa.
The next significant perspective on the definition of an entrepreneur, is that of the resource allocator. This point of view was held by both Say and Casson.
“Entrepreneur is someone who organizes the factors of production.”
– (Say, 1821).
“Entrepreneur coordinate and allocate scarce resources.”
– (Casson, 1990).
In 1828, Jean-Baptiste Say wrote that an entrepreneurs’ main duty was to facilitate and manage factors of production. Say saw the entrepreneur as an individual dictating the various factors of production and in the process taking any residuals as profits. Similar to that of Knight’s perspective, Say also believes that a successful entrepreneur requires certain personal characteristics, including: perseverance, experience and foresight. Say believed that an entrepreneur was resourceful and could overcome challenges. Parker (Reference), states that some people have criticised Say’s definition of an entrepreneur (ie. Link, 1988) but he also confirms that other people contributed opinions similar to that of Say’s perspective (ie. Casson, 2003).
Next we have the point of view of the entrepreneur being an innovator, described by both Schumpeter and Baumol.
“The entrepreneur is seeking out new combinations doing of new things or the doing of things that are already being done in a new way.”
– (Schumpeter, 1934).
“It is his job to locate new ideas and to put them into effect. He must lead, perhaps even inspire; he cannot allow things to get into a rut and for him today’s practice is never good enough for tomorrow.”
– (Baumol, Reference).
Josef Schumpeter saw entrepreneurship and innovation as dependent on each other. He believed that the entrepreneur developed new technologies and/or products, which in turn drove markets forward and that these actions were in turn the principal cause of economic growth (Parker). Schumpeter designed a principle known as ‘creative destruction,’ in which a spike in innovation would hit the economy and in doing so, render certain products and production processes as old and useless. These new products and processes would be followed by a wave of imitation by other competitors[1]. This process meant that if the original entrepreneur did not continue to innovate his product (line), profits would reduce. Schumpeter’s view was that the entrepreneur was not a calculating, risk taker but was a rare and extraordinary individual motivated by natural instinct.
Baumol’s opinion, largely concurred with that of Schumpeter. He saw the entrepreneur as “the Schumpeterian innovator and some more” (Baumol REFERENCE). Baumol expanded on the definition by describing an entrepreneur as an individual who displays business leadership. He is stated as saying that the entrepreneur is someone whom can, “locate a new idea and put it into effect.” (Baumol Reference).
The final major perspective was that of McClelland, that an entrepreneur is defined by their personal traits and psychological profile.
“Characteristics of the entrepreneur are for examples, self-confidence and individual responsibility.”
– (McClelland, 1961).
McClelland was one of the first people to attempt to define a psychological profile of an entrepreneur. He believed that a ‘need for achievement’ (n-Ach), was the key characteristic of a successful entrepreneur, as opposed to that of a desire for money (Parker). In addition to having a ‘n-Ach,’ McClelland contended that an entrepreneur is proactive; enjoy/prefer responsibility of making their own decisions; prefer/enjoy risk; require feedback; and easily get bored i.e. They dislike mundane and monotonous work. He went further to state that individuals could be coached and trained to possess such abilities. Parker (Reference) has stated sources citing the questionability of this statement.
From the above perspectives, a clear range of opinions can be observed amongst different areas of the economic community. What is important to note though, is that there a clear overlaps in these point of views, with some sharing really more than just one of these perspectives. Another interesting thing to note is the similarities and differences between Neoclassical (Cantillon), Austrian (Kirzner) and Schumpeterian (Schumpeter) economists.
First, what are each of these economic theories? Neoclassical theory is based around the belief that the market is always in equilibrium and that economic outcomes are based on the inputs. It is sometimes critised due to the ‘entrepreneur-less’ feature of the theoretical firm in the theory (POWERPOINT REFERENCE). Austrian theory, on the other hand, is based around a belief that the environment of a market also determines the outputs, rather than just purely the inputs. It states that entrepreneurship drives the market towards equilibrium but since the market is also changing, equilibrium is never reached (POWERPOINT REFERENCE). The theory, in turn, suggests that entrepreneurship is the mechanism that ensures markets continue to regenerate and grow. Schumpeter theory is similar to Austrian theory in the sense that they are both include the belief of dynamic market environment, however, Schumpeter theory states that economic growth is dependant on innovation and selection (POWERPOINT REFERENCE). This is reflective of Schumpeters’ definition of the entrepreneur as an ‘innovator’.
When analysing the major differences between Neoclassical and Austrian economic theories, in regards to entrepreneurship, we can divide the differences into three categories � the role of the entrepreneur; the role of innovation and the significance of competition.
First, let us look at the role of the entrepreneur. Fundamentally, neoclassical theory has no role for the entrepreneur, since is based around market equilibrium i.e. no profits. Opposed to this Austrian theory, the entrepreneur is the driver of profit in the market, which in turn pushes the market towards equilibrium (PWP REFERENCe.)
Secondly, the role of discovery. In Neoclassical economics, the theory suggests that decisions and outcomes are not changed or corrected. There is no evolvement or improvement. Conversely, Austrian theory suggests that incorrect decisions are correct by attentive entrepreneurs. That entrepreneurship stimulates further discovery through the profit opportunities presented when errors occur, and this cycle in turn pushes the market towards equilibrium, but it is never reached, due to continuous change (PWP reference).
Finally, what the differences are when considering the significance of competition. Neoclassical theory states that products are sold at consistent, standardised prices on the market. Again, conversely to this, Austrian theory states that further entrepreneurship is spurred by competition, which in turn drives the market (Powerpoint reference).
So it can be seen that the Austrian and Neoclassical theories both treat entrepreneurship in vary different ways. The Austrian and Schumpeter theory are, however, much more similar. Both theories emphasise the dynamic nature of the market. Where they differ is in the fact that Austrian theory states that entrepreneurs assist in pushing the market towards equilibrium, whereas Schumpeter theory sees equilibrium as the starting point for Entrepreneurship. From here entrepreneurs come up with new innovations and in the process push the market away from equilibrium, which in turn generates economic growth and naturally, profits (POWERPOINT REFERENCE).
So now for the interesting part… What’s my opinion? I agree with several of the opinions which I have cited above, and also disagree with others. What I think is most important to recognise is that I do not believe entrepreneurship is bound to one single definition. Entrepreneurship can occur in many different forms and is very much a multi-dimensional concept, which in turn is why it is so difficult to label and define.
One definition I particularly like is that shown below:
An Entrepreneur �
“… manifests ability and willingness of individuals, on their own, in teams within and outside organisations, to: perceive and create new economic opportunities and to introduce their ideas in the market, in the face of uncertainty and other obstacles, by making decisions on location, form and use of resources and institutions.”
– (Wennekers and Thurik 1999: 46-47).
I think that the entrepreneur is a resourceful, intelligent, daring individual who is a fantastic leader, makes the most of the opportunities he or she is presented with, and comes up with new ideas and ways of thinking. They have the ability to overcome difficult situations and they have the confidence to push for what they want. I do not believe an entrepreneur necessarily has to be born with certain personality characteristics to be successful nor do I believe that every entrepreneur can nor should be necessarily trained to have these particular personal traits in order to be successful.
I see Austrian and Schumpeterian theory as more accurate models in terms of the role that entrepreneurs play in the market place. I do not, however, believe that one is necessarily right over the other. I do not personally have an economic background to bias me to either side of the fence, nor do I have a fully, comprehensive understanding of the forces underpinning market equilibrium, but what I can say from my research and studies is that the dynamic nature of a market, is essential for economic growth and that this dynamic nature can largely be created through entrepreneurial behaviour.
Question 3:
During the course theories regarding a potential entrepreneur’s decision to enter a market have been discussed. Assume that you are about to start a new firm. Explain and discuss the factors that would influence your decision to enter or not.
Based on the assumption that I was about to start a new firm there would be a number of factors that would influence my to decision as to whether to enter a market or not. Starting up a business usually requires some level of financial investment, which in turn, suggests some level risk. For this reason, I would want to do my market research in order to determine that I had my facts right.
So the first factors I would investigate would be in regards to what incentives I had to enter a market. I would determine the expected profitability from the product or service I was going to provide. If I was entering an already established market, I could determine this based on the past and present profits of other businesses already selling their products. In this case I would also try to determine what impact my business’s entrance would have on my potential competitor/s eg. whether competitors would or could start a price war, etc. I would also try to determine whether there were any other potential entrants and what role they would play in the market. In the case where I was to open my business in a new market, with a new, innovative product, I would have to research case studies of similar innovative products and the results of their entrance into new markets.
Another major factor that I would need to consider would be the potential growth of the new or existing market I am entering. Are my existing competitors well established? What has past demand been for their products and what is the present demand? I would need to determine roughly what direction and expectations they were projecting for future demand and how my new business could fit into the market place with these projections. This factor could be said to be one of, if not the most crucial in terms of determining the viability of my business.
After analysing the potential incentives for my firm to enter the marketplace, I would need to consider what barriers I could face in establishing my business. Depending on the product or service I intend to provide, it would need to be checked whether there were existing patents or intellectual property rights that could hinder my entry and be too costly to overcome. Also depending on what market I am entering, I would need to determine the extent to which I would need to enter a market in order to be profitable. In other words, I would need to figure out on what scale I would need to execute production in order to compete in the marketplace and whether this level was viable or not. This factor is very much dependant on the financial backing I would have.
Other barriers I could face would pertain to the behaviour of other firms in the marketplace, when considering an established market. If other firms were to limit their prices and increase capacity of production, would I be able to match these figures, whilst not rendering my firm unviable and in the worse case scenario, going bankrupt? I would also need to determine the behavioural strategies of current firms in the market in order to find out whether there were any patterns in their actions, which could in turn affect my business.
Upon collection of this information, if I were to believe that I could match and possibly out-compete other firms on the market; that I could finance the scale of operations I would need to deploy; and that the profit from the business venture was reasonable; I would render the business viable and execute initiation of the firm. If these factors were not met, I would go back to the drawing board and try again.
Reference List:
There are no sources in the current document.
Cantillon, R. (1755). Essai Sur la Nature du Commerce en G� e n� e ral, 1931 edn., ed. and tran. by H. Higgs, London, Macmillan
Knight, F. H. (1921). Risk, Uncertainty and Pro?t, New York, Houghton-Mif?in
Say, J. B. (1828). Cours Complet d’Economie Politique Practique,Paris
Casson, M. (ed.) (1990). Entrepreneurship, London, Edward Elgar (1999). Entrepreneurship and the theory of the ?rm, in Z. J. Acs, B. Carlsson and C. Karlsson (eds.), Entrepreneurship, Small and Medium Sized Enterprises and the Macroeconomy, Cambridge, Cambridge University Press, pp. 45� 781 (2003). The Entrepreneur: An Economic Theory, 2nd edn. Cheltenham, Edward Elgar
H�ebert, R. F. and A. N. Link (1988). The Entrepreneur � Mainstream Views and Radical Critiques, 2nd edn., New York, Praeger
Schumpeter, J. A. (1934). The Theory of Economic Development, Cambridge, MA, Harvard University Press (1939). Business Cycles, New York, McGraw-Hill (1947). The creative response in economic history, Journal of Economic History, 7, pp. 149� 59
Schumpeter, J. A, (1947) “The Creative Response in Economic History” Journal of Economic History, Vol 7 2:149-159.
Baumol, W. J. (1968), “Entrepreneurship in Economic Theory” The American Economic Review, Vol. 58, 2:64-71.
McClelland, D. C. (1961). The Achieving Society,Princeton, Van Nostrand
Powerpoint reference: Assistant professor Kristina Nystr�m Lecture 2: Theory of entrepreneurship 1 2009 KTH
Wennekers S. and R. Thurik, (1999) “Linking Entrepreneurship and Growth” Small Business Economics 13: 27-55
Parker, Simon. C. Economics of Self-Employment and Entrepreneurship.
West Nyack, NY, USA: Cambridge University Press, 2004. p 65.
http://site.ebrary.com/lib/kth/Doc?id=10124670&ppg=85
Copyright © 2004. Cambridge University Press. All rights reserved.
Parker, S. (2004), The Economics of Self-Employment and Entrepreneurship, Cambridge University Press. (Chapter 8) Need to add –
Kirzner, I. M., (1997) “Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach”, Journal of Economic Literature, Vol 35, 1:60-85. (Focus on section III!)
Van Praag M. and P. Versloot, (2007) What is the value of entrepreneurship? A review of recent research, Small Business Economics, Vol 29, 351-382.
Geroski, P., (1995), “What do we know about Entry?”, International Journal of Industrial Organisation, 13, 4:421-440.
[1] A great example of this would be the launch of Apples’ “iPod” and/or “iPhone” � two innovative, exciting products � which have both quickly been followed by a flood of imitations from other competitors.