Theory of Profit

Prof. Hawley, an American economist in 1907, propounded the risk-bearing theory of profit. Prof. Hawley remarks, “The profit of an undertaking, or residue of the product after the claims of land, labour and capital are satisfied, is not the reward of management or coordination but of the risk and responsibilities that the undertaker subjects himself to“.

So, according to this theory, profit is the reward for risk-taking in business. Every business involves some risk or other. Since the entrepreneur undertakes the risk, he is entitled to receive profit. If he does the reward, he will not be prepared to undertake the risks. Hence, higher the risk, the greater is the possibility of profit. This profit of the entrepreneur exceeds the ordinary return on capital. If it were less than the ordinary return on capital, the entrepreneur would not be prepared to undertake the risk.

Knight identifies entrepreneurship as:

  • Recipient of pure profit
  • Pure profit is bearing the cost of uncertainty
  • For which self-confidence is important

Criticisms of this theory

  1. No Direct relationship between Risk and Profit
  2. Reward for Risk avoidance
  3. Unforeseeable Risk

Prof. Knight asserted that the essential functions of an entrepreneur are to bear non insurable risks or uncertainties; he propounded what has come to be known as uncertainty bearing theory of profit.

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