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Risk theory of Profit

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Risk theory of Profit

Risk theory of Profit:-

 The American economist, Professor Frederick Barnard Hawley has put forward the risk theory of profit in his book “Enterprise and productive process” published in 1907 A.D. According to this theory, the main function of an entrepreneur is risk-taking. An entrepreneur coordinates various factors of production and these factors are paid their contractual payments. There is a time lag between the production of goods and their sales. During this time lag, various changes take place. There occur different risks during this change period. The entrepreneur will undertake this risk and gets a reward in return. This reward is known as profit.

             According to Professor Hawley, “The profit of an undertaking is not the reward of management or coordination but of the risk and responsibility.”

             He has stated that there is a proportional relationship between risk and profit. Prof. Hawley pointed out 4 types of risk that an entrepreneur may have to take. They are replacement risk, risk proper, uncertainties, and obsolescence. The real producer of the output is the entrepreneur and not the other factors of production because they are paid fixed remuneration. It is for undertaking all the risk that the entrepreneur is rewarded with profit. Therefore, the residual income left after paying the costs to the factors of production is profit.

Criticisms of Risk theory of profit:-

This theory neglects the difference between insurable risk and uninsurable risks. According to Professor Knight, those risks which are uninsurable gives rise to profit not all types of risks.

1. The reward for reducing risk:-
According to Professor Carver, an entrepreneur does not receive profit because of taking the risk but because of avoiding risk by using his/her intelligence and ability.

2. No proportional relation between risk and profit:-
Critics have pointed out that risk and profit are never proportional. Sometimes more risky enterprise may enjoy low profit than less risky business.

3. Narrow theory:
Critics have pointed out that profit is not only the reward for the risk-taking function of an entrepreneur but also the reward for the organizational and coordinating ability of the entrepreneur.

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