economic theory by shumpeter

7/28/2019 Economic Theory by ShumPeter

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SCHUMPETERIANS ECONOMIC THEORY

OF ENTREPRENEURSHIP


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INTRODUCTION

Joseph Schumpeter, an eminent economist, described entrepreneur as one whoseeks to reform or revolutionize the pattern of production by exploiting aninnovation or more generally, an untried technological possibility for producinga new commodity or producing an old one in a new way, by opening up a newsource of supply of material or a new outlet of products.

Schumpeter was among the first to lay out a clear concept of entrepreneurship.

He distinguished inventions from the entrepreneurs innovations. Schumpeterpointed out that entrepreneurs innovate not just by figuring out how to useinventions, but also by introducing new means of production, new products, andnew forms of organization. These innovations, he argued, take just as much skilland daring as does the process of invention.

Schumpeter, for the first time in 1943, assigned an important role of innovation

to the entrepreneur. He did not equate entrepreneur with an inventor. Aninventor creates a new product while Schumpeters entrepreneur exists if thefactors of production are combined for the first time also. A distinction betweenan inventor and innovator has also been made by Schumpeter. Innovator utilizesdiscoveries in order to make new combinations.


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ECONOMIC DEVELOPMENT

Economic development is the development of economic wealth of countries or

regions for the well-being of their inhabitants.

Economic Growth & development are two different terms used in economics.

Generally speaking economic development refers to the problems ofunderdeveloped countries and economic growth to those of developed

countries.


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JOSEPH.ALOIS. SCHUMPETER


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SCHUMPETERS MODEL OF ECONOMIC DEVELOPMENT

Schumpeter assumes a perfectly competitive economy which is in stationary

equilibrium. In such a stationary state ,there is perfect competitive equilibrium.

no profits, no interest rates, no savings, no investments and no involuntary

unemployment. This equilibrium is characterized by the term circular flow,

continues to repeat itself every year. In the circular flow, the same products are

produced every year in same manner.

According to him economic development is spontaneous and discontinuous

change in the channels of the circular flow, disturbance of equilibrium, which

forever alters and displaces the equilibrium state previously existing

Development consists in the carrying out of new combinations for which

possibilities exist in the stationary state. New combinations come about in the

form ofINNOVATIONS.


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INNOVATIONS

An innovationsmay consist of:

1.The introduction of a new product

2.The introduction of new method of production

3.The opening up of a new market

4.The conquest of a new source of raw materials

5.The carrying out of a new organization of any industry like the

creation of monopoly

According to Schumpeter ,it is the introduction of new product and the

continual improvements in the existing ones that lead to development.


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ROLE OF INNOVATOR

Schumpeter assigns the role of an innovator not to the capitalist but to the

entrepreneur. The entrepreneur is not a man of ordinary managerial ability, but

one who introduces something entirely new. The entrepreneur is motivated by:

a)The desire to find a private commercial kingdom

b)The will to conquer an prove his superiority

c)The joy of creating ,of getting things done ,or simply of exercising onesenergy and ingenuity.

To perform his economic condition ,the entrepreneur requires two thing :

first ,the existence of technical knowledge in order to produce new ;

second, the power of disposal over the factors of production in the formof credit.


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ROLE OF PROFITS

An entrepreneur innovates to earn profits.

Profits are conceived as a surplus over costs :a difference between the total

receipts and outlayas a function of innovation

According to Schumpeter ,under competitive equilibrium the price of each

product just equals its cost of production and there no profits. Profits arise due

to dynamic changes resulting from an innovation. They continue to exist till the

innovation becomes general.


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BREAKING THE CIRCULAR FLOW

Schumpeters model starts with the breaking up of the circular flow with an

innovation in the form of a new product by an entrepreneur for the purpose of

earning profit.

In order to break the circular flow ,the innovating entrepreneurs are financed bybank-credit expansion.

Investment in innovation is risky, they must pay interest on it. Once the new

innovation becomes successful and profitable, other entrepreneurs follow it.

Innovations in one field may induce other innovations in related fields. The

emergence of motor car industry may in, in turn ,stimulate a wave of new

investments in the construction of highways ,rubber tyre etc.


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CYCLICAL PROCESS

Investment is assumed to be financed by creation of bank credit.

It increases money incomes and prices and helps to create a cumulative expansionthroughout the economy.

With the increase in purchasing power of the customers, the demand for theproducts of the old industries increases to the supply.

Price rise ,profit increase and old industries expand by borrowing from the banks. itinduces a secondary wave of credit ,inflation which is superimposed or the primarywave of innovation

After a period the new products start appearing in the market displacing the oldproducts and enforcing process of liquidation and readjustment.

The demand for old product is decreased. Their price fall. some are even forced to

run into liquidation.

As though innovators start repaying bank loans out of profits, the quantity of moneyis decreased and prices tends to fall. profit decline. Uncertainty &the impulse forinnovation is reduced.

Depression entered.


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Analysis begun with the assumption that countrys economic performance is in

rigid condition, i.e., there are no population growth and net investment, and

high level of unemployment. Some entrepreneurs committed to reformation and

followed by other entrepreneurs until there is an increase in investment

The impacts are increasing in societys income and consumption. Thisphenomena will lead the entrepreneurs to increase the new capital.

- induced investmentincreasing of investment because of increasing inincome , production and profit.

- autonomous investmentinvestments which determined by long-termdevelopment, such as new resources found and technology which can createreformation


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The economic development (booming period) will be followed byeconomic recession

- some entrepreneurs who cannot compete with thoseentrepreneurs whose have done reformation will subsequentlyfailed in their business and lost their market and have to close

their business.

- creation of new products will lead to uncertainty among theentrepreneurs in terms investment and capital that are needed for

business development

- Those entrepreneur who are able to create the new productsand market will lead to economic booming However, theequilibrium point is higher than the economic recession period.- With the new equilibrium, the level of per capita income ishigher


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CRITICISMS OF THEORY

1.The entire process of Schumpeter's theory is based on the innovator whom he

regards as an ideal person

2.economic development is the result of the cyclical process

3.Cyclical changes due to innovation is not correct

4.Schumpeter regards innovation as the main cause of economic development

5.Too much importance to bank -credit


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DIAGRAM OF SCHUMPETERS MODEL OF E.D


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CONCLUSION

Schumpeters theory sees the potential profitable opportunities and exploits

them. He is of the view that an entrepreneur does not only desire to raise his

consumption standard by earning handsome profits but aspires to find a private

dynasty also. According to him, an entrepreneur is one who innovates, raises

money, collects inputs, organizes talent, provides leadership and sets the

organization.

According to Schumpeter, innovation leads to the introduction of a new

product, in the market institutes new production technology which is not yet

tested, new quality of product can be brought in, expanding the market by

entering into new markets into which the specific product has not entered so far,

discovering new source of supply of raw materials and helps in carrying out anew form of organization of a business venture.


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Schumpeters theory is based on the following assumptions:

1. Existence of sufficient availability of capital.2. Existence of developed banking system to avoid scarcity of capital.

3. Existence of high level developed technology.

4. Existence of private initiative, and broad based entrepreneurial process.

Considering the above assumptions, it can be inferred that applicability ofSchumpeters theory is more in a developed economy and it may not be suitable

for the underdeveloped economy. It is because in underdeveloped economies,

the path of innovativeness is blocked by scarcity of capital and other facilities

economic theory by shumpeter

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