Understanding of Entrepreneurship and Profits

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Entrepreneurship is the ability to initiate a new business, organize the process of production, and to take risk and Profit is the reward that entrepreneurship or entrepreneurial talent earns.

A. Distinguishing Between Economic Profit, normal profit, and Business, or Accounting, Profit:

1. Economic profit is the difference between total revenues and the opportunity cost of all factors of pro¬duction.

2. Normal profit is the opportunity cost of an entrepreneur's time and talent and is included in a firm's estimated implicit costs-which are costs of input owned by the firm.

3. Accounting profit is total revenue minus total explicit costs-costs of inputs that are purchased by the firm.

B. Explanations of Economic Profit:
1. Restrictions on Entry: Monopoly profits, a form of eco¬nomic profits, are possible when there are barriers to entry.

2. Innovation: The successful innovator obtains a tempo¬rary monopo¬ly position, garnering temporary economic profits. When other firms catch up, those economic profits disappear.

3. Market disequilibrium: It is in the long run that a market or industry achieves its equilibrium and economic profits become zero. In the short run there is a market or industry disequilibrium that makes it possible for some firms to earn varied amounts of economic profits due to:

a. Abrupt changes in demand or supply or both-changes in weather, etc

b. Firms' ability to anticipate changes in demand or supply or both.

c. Firms' superior technology not yet known to their competitors.

C. Reward for Bearing Uninsurable Risks: Many risks can be insured against (fire, flood, earthquake, etc.). Insurance companies do this be¬cause they can predict the percentage of losses and charge customers enough to cover the losses and make a normal rate of return. Some risks cannot be insured against. Entrepreneurs therefore incur uninsurable risks and this is the origin of economic profits according to some economists.

D. The Function of Economic Profit: Profits are the incentive for innovation and investment. They provide an inducement for an industry to expand when demand and supply conditions war¬rant. Conversely, the existence of economic losses indicates that resources in the particular industry are not as valued as they might be elsewhere. These resourc¬es, therefore, move out of that industry. Profits allocate resources.

 

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