Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

4.9 RISK-BEARING AND PROFITS
 
Almost every writer is agreed that profits arise because of 
the risks inherent in the productive organization. Hawley's name is 
prominently associated with this theory. According to him, the 
most essential function of the entrepreneur is risk-taking. Risks 
are inherent in all business, and the assumption of risks is 
necessary if production is to continue. But the bearing of risks is 
unpleasant and irksome. Hence risks would not be borne without 
the expectation of a reward. Profits are the reward for the risks 
that the entrepreneur bears. And the remuneration must be 
something more than the average normal return on the capital 
risked. For, no one would subject himself to risks if, on the 
average, he gets only the normal return to be obtained from safe 
investments. Hence the reward for risk-taking must be higher than 
the actuarial or the average value of the risks borne. 
Moreover, the risks will act as a deterrent to the entrance of 
men into the enterprises. In this way, the supply of entrepreneurs 
willing to embark on risky businesses is diminished, and those 
who venture and survive, secure an excess return because of the 
limitation of competition. 
Very few economists would deny that profits include 
remuneration for risk-taking. But that does not mean that risks 
should take the whole stage to the exclusion of others. Profits, of 
course, go to the person who assumes risks, but do not go only as 
compensation for the risks in proportion to their magnitudes. On 
the other hand, as Carver points out, profits arise not because 
risks are borne, but because the superior entrepreneurs are able 
to reduce risks. Hence paradoxically it may be said that 
businessmen get profit not because of the risks they bear, but 

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because of the risks they do not bear. Further, according to 
Knight, not all kinds of risks give rise to profit. There are certain 
risks which are 'known' in the sense that their average incidence 
can be measured by statistical methods. For example, the 
average risk of death in a community can be statistically 
determined, and a sum can be fixed as premium to cover such 
risks. There are other risks-whose incidence is unknown, i.e., not 
determinable by statistical methods. The remuneration, or 
premium for known risks is not profit but is included in the costs of 
a business ; whereas profits are a surplus above costs. Profits 
arise on account of the assumption of unknown risks. Lastly, it is 
doubtful how far there is a real cost of risk-taking. There seems to 
be little evidence to show that the bulk of the entrepreneurs must 
be paid some additional reward so as to induce them to take up a 
risky business. All that is necessary is that they should know that 
they may make large profits in such businesses. Many people 
remain in business because they value their independence. They 
wish to give orders, not to receive them. That such a position may 
be attended with risks may not deter them from managing their 
own business.