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Business Jargons

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Schumpeter’s Innovation Theory of Profit

Definition: The Innovation Theory of Profit was proposed by Joseph. A. Schumpeter, who believed that an entrepreneur can earn economic profits by introducing successful innovations.

In other words, innovation theory of profit posits that the main function of an entrepreneur is to introduce innovations and the profit in the form of reward is given for his performance. According to Schumpeter, innovation refers to any new policy that an entrepreneur undertakes to reduce the overall cost of production or increase the demand for his products.

Thus, innovation can be classified into two categories; The first category includes all those activities which reduce the overall cost of production such as the introduction of a new method or technique of production, the introduction of new machinery, innovative methods of organizing the industry, etc.

The second category of innovation includes all such activities which increase the demand for a product. Such as the introduction of a new commodity or new quality goods, the emergence or opening of a new market, finding new sources of raw material, a new variety or a design of the product, etc.

The innovation theory of profit posits that the entrepreneur gains profit if his innovation is successful either in reducing the overall cost of production or increasing the demand for his product. Often, the profits earned are for a shorter duration as the competitors imitate the innovation, thereby ceasing the innovation to be new or novice. Earlier, the entrepreneur was enjoying a monopoly position in the market as innovation was confined to himself and was earning larger profits. But after some time, with the others imitating the innovation, the profits started disappearing.

An entrepreneur can earn larger profits for a longer duration if the law allows him to patent his innovation. Such as a design of a product is patented to discourage others to imitate it. Over the time, the supply of factors remaining the same, the factor prices tend to rise as a result of which the cost of production also increases. On the other hand, with the firms adopting innovations the supply of good sand services increases and their prices fall. Thus, on one hand the output per unit cost increases while on the other hand the per unit revenue decreases.

There is a point of time when the difference between the costs and receipts gets disappear. Thus, the profit in excess of the normal profit disappears. This innovation process continues and also the profits continue to appear or disappear.

Related terms:

  1. Clark’s Dynamic Theory of Profit
  2. Hawley’s Risk Theory of Profit
  3. Walker’s Theory of Profit
  4. Theories of Profit
  5. Knight’s Theory of Profit

Reader Interactions

Comments

  1. Jewell says

    July 16, 2019 at 6:10 pm

    Excellent summary

    Reply
  2. Sonali says

    January 17, 2021 at 11:37 am

    It was awesome explanation regarding this topic and very helpful in gaining informative things______😊

    Reply
  3. Ife Ade says

    March 3, 2021 at 7:53 pm

    Great article. Kindly provide citation details for this article. I ‘m using it for research work. Thanks

    Reply
  4. Brian says

    July 1, 2021 at 10:14 pm

    This piece really helped me.
    Thanks

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  5. Sharine Jamlan says

    September 21, 2021 at 1:07 pm

    Kindly provide citation. Thanks

    Reply
  6. Rambui says

    November 12, 2021 at 3:28 pm

    Nice summary and simpler to understand. Thanks. Some citations can do better.

    Reply
  7. Musavi says

    April 26, 2022 at 12:04 pm

    Wonderful explanation vith simplest method..
    Thank you very much

    Reply
  8. JOMAR Folgueras says

    September 5, 2022 at 7:08 pm

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  9. prime says

    September 27, 2023 at 5:24 pm

    I look everywhere for this. Thank you!

    Reply
  10. Cynthia Siziba says

    October 9, 2023 at 7:42 am

    A good summary, it really helped me a lot.

    Reply

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