Entrepreneurship and Economy

Dipesh Karki (dipeshkarki510@hotmail.com)

BE (Computer), MA (Economics)

A. Introduction Entrepreneurship is an enterprising act of an individual with sole motivation of generating capital and profit against the entrepreneurial risk. The key driving force of any entrepreneurial venture is an innovation. As a result of which new job and opportunity becomes available. According to Joseph Schumpeter in his celebrated book Capitalism, Socialism and Democracyi an entrepreneur is a person who is willing and able to convert a new idea or invention into a successful innovation. Therefore entrepreneurial activity acts as an economic multiplier leading to economic growth. In microeconomics along with capital, labor and land, entrepreneurship makes up the factor of production. Each of these factors when employed yields return which are as follows - interest for capital, wage for labor, rent for land and profit for entrepreneurship. According to William Baumolii Entrepreneurship is the act of starting new firms, introducing new products and technological innovations and in general, taking the risks that is necessary to seek out business opportunities. B. Motivation towards entrepreneurship In general it is difficult to characterize entrepreneur under certain description as their behavior is very fluid- constantly seeking to do something new. However three fundamental ways have been identified by which entrepreneur gets profit as a risk premium over the risk free interest rates: i) Monopoly Power: Entrepreneurs are generally early innovators and they mostly have patented their innovation as a result they may establish monopoly power for short duration thus receiving marginal profit gain. Also even if they dont hold patent the entrepreneur will be one step ahead of their competitors thus enjoying pseudo monopoly over a short period. Risk Bearing: Though Joseph Schumpeter considers it is capitalist who bears risk in innovation, Peter Drucker meanwhile believes entrepreneur are the one who bear the substantial risk as they are willing to sacrifice both time and financial security for uncertain venture. According Frank Knight risk constitutes randomness which can be either measurable or uncertain. On this regard, a capitalists investment falls under measurable risk as it can be estimated by statistical measure on the other hand the entrepreneurial risk falls under the class of uncertainty. For instance an oil drilling company will have to make several exploratory expedition among which only few could lead to actual oil while other attempts brings no return. Thus successful innovation generally have larger payoff that will cover the clear and present danger of loss due to uncertainty involved. Return to innovation: Innovation is a way of putting new invention into practical use. According to Schumpeter Innovation is creative destruction such that old inefficient

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business is replaced by new and efficient business. For example cars replacing draw cart. This innovation provides the fuel for growth and as a result creates new market thus providing greater returns. C. Relationship between entrepreneurship and economic growth In Theory of Economic Development, Joseph Schumpeter has emphasized the role of entrepreneur as prime cause of economic development. However the impact of entrepreneurial venture in overall economic growth is conspicuously absent in seminal Solows growth modeliii, which correlates growth with capital, labor and technological factor. As a result the impact of entrepreneurship in overall economy has always been understated. Despite this recent studies have emphasized the greater role of entrepreneurship for sound economy. The literatureiv mainly depicts three different types of entrepreneurs with each having varying impact on economy. They are: i) ii) iii) Innovating entrepreneurv: Also called Schumpeter entrepreneur they are the ones who carry out new combination called enterprise Kirznerian or neo-Austrian entrepreneurvi: They are the class of entrepreneur whose sole aim is profit motive and they dont own any capital. They are opportunity seekers. Knightian entrepreneurvii or neo-classical entrepreneur: These are class of entrepreneur who owns resources and assumes the role of risk taker.

The impact of Kirznerian and Knightian entrepreneur in determining output level and number of entrepreneur can be explained mathematically by Carrying Capacity Modelviii by Caree and Thurik which can be expressed by following equations: -

Where, : Critical Profit level : Variable Cost per unit Total Output in market : Total number of entrepreneur producing same output in : Size of fixed cost : size of market market

The model can be best explained by following simple illustration: Let us consider there are two market i and j with same size that is . Let the fixed cost and profit level be =1. And the let the variable cost per unit be =0.1 then from above formula

We can obtain, Or, 1= 50/ Or, Therefore number of entrepreneur in single market is 5. And hence combined total 10 entrepreneurs are present in two market I and j. Similarly using second equation 1

Again, substituting the respective values we can obtain, Or, 1= (0.1 * / ( 5 * 4) -1

Or, 40=0.1 * Or, Thus the total output of single market is 400 and hence total output for combined market of I and j is 800. Kirzinerian effect: Lets suppose that unlike the equilibrium condition stated in above illustration where both market consisted of 5 entrepreneurs each, market i consist of 4 entrepreneurs and market j contains 6 entrepreneurs. This condition implies that market j is crowded due to lack of profit motive which inhibits the entrepreneur from market j to relocate to market i then in this scenario using the second equation again we obtain that total output amounts to total 792 where and . Thus decrease in number of Kirzinerian entrepreneur leads to low output resulting in diseconomy. Knightian effect: Again in same illustration lets suppose that the entrepreneur is risk averse that is they are willing to invest only if critical profit level is 1.5, then substituting value =1.5 and at ceteris paribus the equation yields that number of entrepreneur in each market will fall to 4 .47 and the total output will drop to 776. Therefore decrease in Knightian entrepreneur again leads to fall in output and diseconomy. In summary Carrying Capacity Model given by the above equation shows that in market there exists critical profit level that entrepreneur seek to receive as compensation to their effort. If the profit level is low then entrepreneur will exit until the level returns back to critical level. Meanwhile the opposite scenario will unfold when profit level is high. Schumpeterian effect: Though Carrying Cost Model is able to explain the effect of Knightian and Kirzinerian entrepreneur in economic growth; it fails to explain the role of Schumpeter entrepreneur in overall economy. Since mathematical modeling of innovation is difficult to carryout there has been

dearth in generalization of Schumpeter effect in economic growth. However, recently Aghion and Howitt have attempted to describe the effect of Schumpeterian creative destruction into the growth modelix. According to this model Schumpeter entrepreneur invest on research and development to bring about next great product with aim of realizing the temporary monopoly rent as the existing product will be replaced. Once the product becomes saturated, the entrepreneurs will again seek innovation to bring forth new change. This effect of forward looking will bring about new employment opportunity thus leading to economic growth. D. Conclusion In conclusion it can be stated that unlike other factors of production, entrepreneurship is vague and hard to define as various economists have explained it in different ways. Despite the variance in its definition, entrepreneurship is the key driving force in overall economic growth and development. Its importance is underscored by former president of European Commission, Romano Prodi who once proclaimedx that the promotion of entrepreneurship as the cornerstone for European Economic Growth policy. In todays context because of inadequacies of traditional parameter of policy such as capital investment to spurt the growth, policy makers are adopting the concept of entrepreneurial capital as the missing link which provides the mechanism for translating knowledge growth (innovation) towards increased return of investment.xi Especially for resource scarce country like ours need for entrepreneurial capital is even greater as self-employment and job creation are fundamental requirement for sustainable economic growth. E. REFERENCES
i rd

Schumpeter, Joseph. Capitalism, Socialism and Democracy. 3

ed. New York: Harper-Collins, 1950.

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Baumol, William J. and Alan S. Blinder. Microeconomics, Principles and Policy, 9 ed. Mason, Ohio:Thomson South-Western, 2003.
iii

Solow, R. (1956). A Contribution to the Theory of Economic Growth, Quarterly Journal of Economics, 70(1), 6594. iv Carree, M.A. and Thurik, A.R. The impact of Entrepreneurship in Economic Growth. International Handbook of Entrepreneurship Research, 2002.
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Schumpeter, J.A. (1934). The Theory of Economic Development, Cambridge, MA: Harvard University Press.

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Kirzner, I.M. (1997). Entrepreneurial discovery and the competitive market process: an Austrian approach, Journal of Economic Literature 35, 60-85.
vii

Knight, F. H (1921). Risk Uncertainty and Profit, Houghton Mifflin and Co.

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Carree, M.A. and A.R. Thurik (1999). The carrying capacity and entry and exit flows in retailing, International Journal of Industrial Organization 17, 985-1007.
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Aghion, P. and P. Howitt (1992). A model of growth through creative destruction, Econometrica 60, 323-351.

Prodi, R. (2002).For a New European Entrepreneurship, public speech, Madrid, Instituto de Empresa

xi

Audretsch, D.B.(2007). Entrepreneurship capital and economic growth. Oxford Review of Economic policy, 23(1),63-78.