DEPARTMENT OF TECHNICAL EDUCATION

ANDHRA PRADESH
Name : G. M. Lakshmi
Designation : Lecturer
Institution : GPW Suryapet.
Branch : DCCP
Year/Semester : VI th semester
Subject : Business Economics II
Subject Code : CCP-602.
Main topic : Theories of Profits
Sub-topic :Innovation theory of profit
Duration : 50 minutes.
Teaching Aids : PPT, Animations
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Objectives:

On the completion of this period you would be

able to know:

 The Innovation theory of profit

 Criticisms against the theory

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 Recap
 Uncertainty theory was formulated by Prof.Knight

 According to him, profits are the result of uncertainty

 This theory was criticized by many economists.

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 Innovation theory of profit

• Prof. Schumpeter is the father of innovation theory of

profits

• The entrepreneur initiates innovation and when he

succeeds gets profits

• He also attributes profits to dynamic changes

• He resorts to the device of innovations to explain the

emergence of profits.

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 Contd…
 So innovation is the root cause of profits according

to Schumpeter.

An innovation can be:

 The introduction of a new product in to the market.

 Discovery of a new market.

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 Contd…
 Introduction of a new method of production either
by a new machine or by a new method or
organization

 Discovery of a new source of raw material

 Substantial reorganization of industry.

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 Contd…
 Under stable conditions, costs and prices are equal
and therefore there will not be any profits.

 Innovation gives an advantage to the innovating

organizer.

 Disequilibrium sets in and the innovator gets profits.

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 Contd…
 Thus according to Schumpeter profit is a reward for
innovations.

 His theory has the following important points.

5. Profits are both the cause and effect of innovations

 Technical knowledge is required for innovations

 Innovations give profits and profits encourage such

innovative research.
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2. Innovations profit cannot be permanent.

 A new product enjoys profits only temporarily.

 When competitors begin to imitate it ,substitutes come

into the market.

 Thus competition increases.

 This reduces the profits of the innovator

 The innovator after sometime gets normal profits.

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 Contd…

 Again another invention is to be made to get super

profits.

 So innovation is a continues process.

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Criticisms:

Schumpeter’s theory has the following defects:

 This theory fails to grasp the importance of risk and

uncertainty.

 Afterall an innovation itself may be considered as

having a risk element into it.

 There is no guarantee that an innovation will be a

ready success.

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 Contd…
 Innovation is not the only function of an organizer.

 He does many other functions also.

 Many producers are earning profits even without

innovations.

 Both Clark and Schumpeter fail to recognize the

influence of unforeseen risks.

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 Contd…
 This theory cannot explain the existence of
monopoly profits.

 Monopoly profits are permanent and they do not

disappear like innovation profits.

 If a monopoly continues to exist, profits continue to

accrue.

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Summary:
 Schumpeter says innovation give rise to profits.

 With innovations either the cost of production is

lowered, or the product fetches a higher price.

 It may be pointed out however, that profits owing to

innovations are only temporary and tend to be
competed.

 Thus Schumpeter’s theory of profits is also defective

and incomplete.
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 Quiz
1. Innovation theory of profits is advocated by:

c. Prof. Knight
d. . Marshall
e. Schumpeter
f. None of the above

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2. Schumpeter says:
b) Innovations bring profits
c) Profits are reward for performing innovations
d) Both A and B
e) None of the above

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3. Schumpeter says:
b. Technical knowledge give profits
c. Profits encourage innovative research
d. Innovative profits cannot be permanent
e. All the above

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Frequently Asked Questions

1. Explain briefly the innovative theory of profits or

“profit is the reward for innovation-” explain?

2. What are the different types of innovations?

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Thank You

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