Uncertainty Bearing Theory Of Profit

Uncertainty Bearing Theory Of Profit:-

The uncertainty-bearing theory of profit was propounded by the American economist Prof. F. H. Knight in his book risk, uncertainty, and profit, published in 1921 A. D. This theory is an improvement over Hawley's risk theory of profit. Prof. Knight has focused and explained the uncertainty and distinguished it from risk. According to him, the risk is a situation in which the statistical probability of an outcome can be determined and can be minimized or reduced to naught (zero). According to Knight, profit is the reward of bearing uncertainties which are not insurable but the risk can be insured.

Professor Knight has distinguished between insurable risk and uninsurable uncertainties as follows:-

1. Insurable risk:-

The risks which are predictable and can be insured against on payment of an insurance premium are known as risks. E.g.:- Risks of a factory caught fire, theft or accident, etc. The insurable risk will not give any reward to an entrepreneur.

2. Uninsurable uncertainties:-

The risks which are unpredictable or uninsurable are known as uncertainties. E.g. :- Reduction in demand, change in government policies, increase in competition, etc. An entrepreneur bears these uncertainties and gets a reward in return which is called profit. The risks which cannot be predicted are explained as follows:-

a. Uncertainty in market condition:-
The change in demand and supply conditions in the market lead the entrepreneur to uncertainty.

b. Competitive uncertainty:-
When new firms enter the market, it increases competition among themselves and the profit of existing firm will become uncertain.

c. Innovation:-
Due to the introduction of new technology, machines and capital goods need to be replaced before they become obsolete. Thus, the uncertainties of entrepreneur increases due to innovations.

d. Economic policies:-
Economic policies can be classified into microeconomic policy and macroeconomic policy. Because of the change in these policies, the entrepreneurs may get windfall gains or suffer losses.

e. Business cycle:-
The business cycle also called the trade cycle is a common feature of a capitalist economy. It refers to the fluctuation in the economic activity which changes aggregate demand and aggregate supply. Consequently, business uncertainties of the entrepreneur grow.

Criticisms of the uncertainty-bearing theory of profit:-

1. No profit despite uncertainty-bearing:-
Critics pointed out that sometimes an entrepreneur earns no profit even after taking uncertainties.

2. Incomplete theory:-
Profit is not the reward for bearing uncertainties. According to critics, other causes like coordinating, bargaining, etc. also give profits. So, it is an incomplete theory of profit.

3. Not applicable in case of a joint stock company:-
The shareholders of joint stock companies who are entitled to a profit, do not perform any functions of an entrepreneur.

4. Unable to explain monopoly profit:-
This theory does not suit well to expose the phenomenon of monopoly profit, where there is very less uncertainty involved in a monopoly business.