Innovation Theory of Profits

This theory was introduced by Professor Josheph A. Schumpeter. He has focused on mainly-

 He has used the word innovation in a very wide sense. According to Josheph A. Schumpeter, the main function of entrepreneur is to introduce innovation in the economy and profit are a reward for performing this function.

According to him, any new measure or policy adopted by an entrepreneur to reduce his cost of production or to increase the demand for his product is an innovation. Thus, innovations include the introduction of a new machinery new technique of production, exploitation of a new source of raw material, new and better method of organisation, introduction of new product, a new variety or design of the product, New method of advertisement, discovery of new markets, etc. If an innovation proves successful, that is, if it achieves the aim of either reducing the cost of production or increasing the demand for the product, it will automatically give rise to profits.

According to Prof. Schumpeter, "The main purpose of introducing innovations by the entrepreneur is to earn profit. Therefore, profit is the cause of innovations and if innovations prove to be successful, he will earn profits. Means, Profit is both the cause as well as the effect of innovations.

Prof. Schumpeter has focused and discussed about Inventions and Innovations, we will discuss about it.

Invention is a scientific discovery, while innovation refers to the commercial application of the invention.

Another point to be noted is that inventions by themselves do not give rise to profits. The entrepreneurs may have known or heard about the inventions, they may be having a perfect knowledge about it, but unless, the inventions are used, introduced and put into practice, profits will not rise. According to him, thus, it is not mere inventions as such, but the adoption of these inventions which give rise to profits. Those entrepreneur who have the foresight, imagination, courage and wisdom to adopt these inventions, earn profits, while others lag behind.

Prof. Schumpeter, in his innovation theory of profits have discussed about the temporary Reward.

According to him, profits arising out a particular innovations are only for a temporary period and tend to be competed away soon as other entrepreneurs come to know of that innovation and adopt it.

An innovation ceases to be new or novel, the moment others come to know it and adopt it. Thus when an entrepreneur introduces a new innovation, he is first in a monopoly position because it is he alone who has adopted it and therefore he earns profits. But after sometime other entrepreneurs come to know that innovation and adopt it with the result that the profits are completed away and they disappear.

But in a competitive and progressive economy, the entrepreneurs always continue to introduce and adopt new innovations and thus continue to earn profits.