Economics

Knight’s Uncertainty Theory of Profits And Its Limitations

Uncertainty Theory of Profits : Uncertainty Theory Of Profit has formulated by Prof. Knight. According to Prof. Knight the main function of the entrepreneur is Uncertainty bearing and not risk taking. He divides risks into two classes. 1 ) Foreseeable risks and, 2) Unforeseeable risks.

1. Foreseeable Risks : These risks can be foreseen and estimated in advance. Example, fire accidents, marine accidents, theft etc. All these risks can be ensured with an insurance company. If there is any loss that insurance company pays the total value of the lost property. Thus, this kind of risks will be born by insurance companies and got by the entrepreneur. The entrepreneur gets no profits on account of these risks.

2. Unforeseeable Risks: These risks cannot be foreseen and predicted accurately. According to Knight these unforeseen risks are known as uncertainties, as they cannot be known and foreseen. Following are some of the unforeseeable risks.

1) Changes in prices due to technological changes,

2) Decrease in the demand due to changes in tastes and fashions, population, incomes etc.

3) Competition from new firms or new products,

4) Government may interfere into the affairs of the industry and fix lower prices,

5) Cyclical economic depressions resulting in lack of demand, falling prices etc.

Since these risks cannot be foreseen and estimated accurately no insurance company will be prepared to cover against them. Hence, these are called uncertainties. According to Prof. Knight there is a direct relationship between profit and uncertainty bearing. Greater the uncertainty bearing, the higher will be the level of profits and vice versa. Uncertainty hearing has become so important in business. So, uncertainty bearing is regarded as a separate factor of production. The entrepreneur himself has to bear these uncertainties. But all persons are not capable of undertaking uncertainties. So, uncertainties restrict the supply of entrepreneurs. According to Prof. Knight profit is the reward for bearing these uncertainties.

Criticism of Uncertainty Theory of Profits:

This theory has been criticized on the following grounds

1. Supply of entrepreneurs : Prof. Knight says that the supply of entrepreneurs is restricted due to uncertainty bearing. But it is not the only factor that restricts the supply of entrepreneurs. There are some other factors like lack of funds, lack of knowledge, lack of opportunities etc.

2. Functions of entrepreneur : Uncertainty bearing is not the only function of entrepreneur. He performs many other functions like co-ordination, supervision and innovation.

3. Separate factor : Uncertainty bearing cannot be treated as a separate factor or production.

4. Relationship between profits and uncertainty : Knight said that the profit is the outcome of uncertainty bearing. But there is no relationship between profits and uncertainty. In reality we find the level of profits are more in industries where there are no uncertainties.

5. Determination of profit : Some critics pointed out that this theory does not explain how the rate of profits can be determined.

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