Incentives, Profit and the Entrepreneur

Key Terms

* Profit
* Competition
* Property rights
* Incentives
* Entrepreneur
* Residual claimant
* Resource allocation

Lesson Objectives

Profit is an incentive; it motivates entrepreneurs to accept the risk of acquiring and organizing resources to seek market opportunities.

The expectation of profit encourages increases in production and attracts new suppliers; lack of profit signals businesses to reduce production or exit the market.

Competition, including entry of new businesses, reduces margins of profit and encourages an on-going search for improved products and lower-cost methods of production.

Governments encourage entrepreneurial activity when they secure clear property rights and protect freedom of exchange.

When there is no residual claimant, there is less incentive to reduce the costs of providing goods and services or to improve product quality and service.


1. Differentiate between accounting profit and economic profit.

2. Suppose that, many people are angry about the profiteering of drug companies, a bill has been introduced to have one company take over the production of all drugs.

Predict the result of such legislation:

a) What will happen to the price of drugs?
b) Who will pay?
c) How will we decide which drugs will be produced?
d) What will happen to the discovery of new, safe, and effective drugs?
e) How will decisions be made about which diseases drug research should target?


Definitions

Entrepreneur - One who is willing to risk loss in the attempt to make a profit from reorganizing market resources from low-valued to high valued uses. Entrepreneurs undertake the task of coordinating the employment of land, labor, and capital to produce goods and services.

Incentives - Rewards or punishments for behavior.

Profit - The difference between total revenue and total cost.

Property rights - The conditions of ownership, including the rights and restrictions regarding use, ownership, and sale.

Residual claimant - The owner of whatever is left (either profit or loss) when all the costs of production and sale have been accounted for. Entrepreneurs, by virtue of their willingness to risk failure, are the residual claimants to the profits of their enterprises.

Resource allocation - The method(s) used to determine ownership (property rights) to land, labor, and capital.