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Theories of Entrepreneurship

Chapter 4
Theories of Entrepreneurship

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Theories of Entrepreneurship

"I studied the lives of great men and famous women, and I found that the men and women who got to the top were those who did the jobs they had in hand, with everything they had of energy and enthusiasm and hard work." Harry Truman, Former U.S. President

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Introduction

Theories of Entrepreneurship

Entrepreneurship development has recently become a matter of serious interest


and necessary study throughout the world. There are many theories forwarded by a number of eminent scholars. Almost all the theories may broadly be grouped into three schools of thoughtsone based on economic principles, the exponents of

which are Leibenstein, Hayek Kriznor and Knight, the second one on
psychological aspect and the third one on sociological aspect, in which the contributions of Schumpeter, McClelland, Hagen and Kunkel are worthmentioning. The socio-economic, socio-psychological and socio-environmental factors have played the fundamental role in the formation and development of entrepreneurship. But entrepreneurship is basically an economic concept and so the theories relating to entrepreneurship are mainly introduced by the economists.
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Theories of Entrepreneurship

Some of the theories have been discussed below:


1. Theory of Social Change enunciated by Max Weber advocates that in the context of social changes, the activities of an entrepreneur are conducted. 2. The Theory of Social Change propounded by Cochran states that entrepreneur is formed on the basis of cultural values and he is one of the topmost persons of the society. 3. Hosetitz in his Theory of Culture has suggested that certain persons are

endowed with creative power in any cultural or social group and they develop
different theories while practicing social conduct. 4. McClelland in his Need for Achievement Theory has stated that human beings work better in the hope of getting something and this desire induces him

to work. In order to accept the challenge for risk-taking, people develop


enterprises with hard labour.
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5.

Theories of Entrepreneurship

Bowen and Hisrich have developed a new theory, known as Life-Cycle Theory in which it has been stated that formation and development of entrepreneur are dependent on the following factors:

i.
ii. iii.

educational environment;
personality of an individual; need for achievement;

iv. focal point of control;


v. tendency for risk-taking;

vi. family atmosphere in childhood; vii. history of work and viii. present work situation.

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Theories of Entrepreneurship

Leibensteins X-efficiency Theory


In 1968, H. Leibenstein has published the X-efficiency Theory in his book Entrepreneurship and Development. The term X-efficiency has been used in the negative sense. This theory has recently been applied to analyse the role of the entrepreneurs. In this theory, he explained the degree of inefficiency of using resources in the concern. X-efficiency is the degree of the inefficiency in the use of resources within the firm; it measures the extent to which the firm fails to realise its productive potential. With its help, it has been tried to realise why the productive capacity of a concern cannot be measured. X-efficiency is meant to refer that the actual cost of production of a commodity exceeds the minimum cost of production. X-efficiency arises either because the firms resources are used in the wrong way or because they are wasted.
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Theories of Entrepreneurship

Hayeks Market Process Theory


In 1951, Frederick A. Von Hayek, an Austrian economist, introduced an

economic theory, regarding entrepreneurship development. This theory is


known as Market Process Theory. In every economic system, a complex network of relations determines what is to be produced, how to be produced and for whom it is to be produced. One important system for finding out the answers to these three fundamental questions refers to market economy. The economic system sets the rules and regulations governing economic

activity. It determines the ownership of the factor of production and property


rights, distributes the power of decision-making on production and consumption.

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Theories of Entrepreneurship

Role of Entrepreneur under Market Process Theory

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Theories of Entrepreneurship

Market System or Market Process In a free market system, firms procure various factors and produce output that will maximise their profits. Consumers supply factors and purchase consumer goods to maximise their satisfaction. Agreements on production and consumption are made voluntarily and thus the state of equilibrium is attained. In the opinion of Hayek, market process depends upon the structure of

production. In order to increase the volume of production, it is essential to


follow the method of specialisation. If specialisation is applied, the intermediary steps or processes can be lengthened. This leads to increase the scale of production. If the production structure is expanded, production of capital goods

can be increased. Conversely, if the production structure is contracted,


production of capital goods will be less.
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Theories of Entrepreneurship

Hayek has also viewed that during the period of rising prices, real wages will fall. The Market Process Theory of Hayek is also known as Theory of over investment. As per this theory, a difference in prevailing rate of interest leads to another

difference in the case of investment also, which, in turn exerts an influence on


the expansion or contraction of enterprises. The main theme of this theory relates to the fact that a reduction in the market rate of interest inspires the entrepreneurs to invest more and conversely, an increase in the market rate of interest disappoints them to invest. Since the activities of the entrepreneurs are influenced by fluctuation in the market rate of interest, this theory is known as Market Process Theory.
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Theories of Entrepreneurship

Global Economy

Market Equilibrium

Acquisition of Knowledge and Information

Utilisation of Knowledge and Information

Communication or application of Knowledge & Information

Activities of Entrepreneur

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Risk-bearing Theory of Knight


In 1940, Prof. Frank H. Knight has introduced his Risk-bearing theory through a research paper brought out in the name of Risk, Uncertainty and Profit. The commercial world is full of uncertainty. There is no certainty about marketability of a product. So, risk will naturally arise. For this, the decision-making relating to production and distribution is not always fruitful or logical.

Prior to Knights publication of this theory, F.B. Hawley has brought out the Risk-bearing Theory. Knight theory is developed on the basis of Hawleys theory. According to Hawley, profit is the reward for risk-taking by the entrepreneur. The profit has no relation with the reward for managing or coordinating. Rather, profit is indicated as a reward for accepting responsibility and risk-bearing since the function of risk-bearing is the function of the entrepreneur. The opinion of Knight is similar to this conception. He thinks the risk-bearing as the chief function of the entrepreneur. In fact, this is recognised as theory of profit.
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Theories of Entrepreneurship

Schumpeters Theory of Innovation


J. A. Schumpeter (1883-1950), an Austrian Economist, has brought out his
famous book The Theory of Economic Developmen from U.S.A. in 1934. Schumpeters theory of innovation is the most remarkable one simply because, he is the first man who has been able to forward a clear idea about economic activities of an entrepreneur and impact of those activities on economic situation. Apart from this, he is the first man who has been regarded as a principal theorist. In his opinion, the concept of entrepreneurship and entrepreneur is applicable in a dynamic economy only. He has stressed more importance to human agent in the focal point of economic development process.
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Theories of Entrepreneurship

He has remarked that an entrepreneur is such a person who brings innovation in economic activities. An entrepreneur is the fundamental key to development and an important variable in development equation. An innovator is such a person who creates obstacles to the present state of equilibrium and develops the economy to a new stage. An entrepreneur is known as the main steer man of the economic development of a country.

According to his conception, development refers to carrying out new combinations.

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Sum Up

Theories of Entrepreneurship

Theory of Social Change enunciated by Max Weber advocates that in the context of social changes, the activities of an entrepreneur are conducted. The Theory of Social Change propounded by Cochran states that entrepreneur is formed on the basis of cultural values. Hosetitz in his Theory of Culture has suggested that certain persons are endowed with creative power in any cultural or social group and they develop different theories while practicing social conduct. Apart from this, some other theories of entrepreneurship are also worthmentioning. Leibensteins X-efficiency theory has been applied to analyse the role of the entrepreneurs. Hayeks market process theory asserts that rational economic organisation is logically impossible in the absence of free market. Prof knights risk-bearing theory explains the risk in any business situation on account of uncertainty elements. Schumpeters theory of innovation is the most remarkable. He has stressed more importance to human agent in the focal point of economic development process.
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