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Home » Economics Homework Help » Microeconomics Help » Profit Innovation Theory
Profit Innovation Theory
Successful innovations as important dynamic changes have been singled out as a very important factor responsible for the occurrence of profits to the entrepreneurs it requires to be dealt with separately. It has been held by Joseph Schumpeter that the main function of the entrepreneur is to introduce innovations in the economy and profits are reward for his performing this function. Now, what is innovation? Innovation, as used by Schumpeter, has a very wide connotation. Any new measure for his product is an innovation. Thus innovations can be divided into three categories.

First type of innovations is those which reduce cost of production, or in other words, which change the production, or in other words, which change the production functions. In the first type of innovations are included the introduction of a new machinery, new and cheaper technique or process of production, utilization of a new source of raw material, a new and better method of organizing the firm, etc. second type of innovations are those which increase the demand for the product, or in other words, which change the demand or those which increase utility function. In this category are included the introduction of a new product, a new variety or design of the product, a new and superior method of advertisement, discovery of new markets etc. if and innovation proves successful innovations either cost falls below the prevailing price of the product or the entrepreneur I sable to sell more and better price than before. It should be noted that profits accrue not to him who conceives innovation is to be introduced, it always calls for a new combination of factors or reallocation is to be introduced it always calls for a new combination of factors or reallocation of resources.

It is here worth mentioning that profits caused by a particular innovation are only temporary and tend to be competed away as others imitate and also adopt that. An innovation ceases to be new or novel, when others also come to know of it and adopt it. When an entrepreneur introduces a new innovation, he is first in a monopoly position, for the new innovation is confined to him only. He therefore makes large profits. When after some time others also adopt it in order to get a share, profits will disappear. If the law allows and the entrepreneur is able to get his new innovation e.g. new product patended, then he will continue to earn profits.

But in a competitive economy and without patent laws, the existing competitors or the new firms will soon adopt any successful innovation and profits would be eliminated. But in a competitive and progressive economy the entrepreneurs always continue to introduce new innovations and thus profits continue emerging out of them. Unless one can construct a permanent monopoly, such profits as are realized by successful innovations are essentially transitional and will be eliminated by the attempts of other firms to share them. But these profits may exist for a considerable time because of the ignorance of other firms of their existence or because of the time required for the entry of new firms. More important, the successful innovator can continuously seek new disequilibrium profits since the horizon of conceivable innovations is unlimited.

We have seen above that innovations are important source of profits. Obtaining profits is a necessary incentive for the entrepreneurs to conceive and introduce innovations which help the economic development of the country. Since innovations, if successful, yield profits and profit is also the motive to introduce innovations, profits are both the cause and effect o finnovations.

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