How Do Principles Textbooks Treat the Return to Entrepreneurship? The Missing Factor.

AuthorEstill, John
  1. Introduction

    Going back to the 1980s, economists have commented on how traditional microeconomic principles textbooks have said little about entrepreneurship (Kent 1989; Kent and Rushing 1999). Since then, most textbook authors have added information on entrepreneurs. However, the actual contribution of the entrepreneur in the calculation of profits and a normal rate of return has not generally made this transition. (1) A significant disconnect exists between how textbook authors define the entrepreneur's role and how they explain the actual return to entrepreneurial activity.

    Too often, economic principles students exit the course with a complete misunderstanding of the entrepreneur's actual contribution and how one determines the costs necessary for an entrepreneur to make good decisions. Yet entrepreneurship, economic profits, and a normal rate of return are essential topics to understanding a market economy. The failure to address these topics consistently makes it appear that economists are merely waving their hands in presenting these topics in the classroom. Finally, if these topics are not presented adequately at the principles level, one might assume that they are not presented adequately at the intermediate or graduate level, either.

  2. The Role of the Entrepreneur and His Compensation

    Adam Smith identifies and discusses three components of a commodity's price: labor, stock, and land. However, he points out that there may be confusion when the same person supplies all inputs:

    When those three different sorts of revenue belong to different persons, they are readily distinguishable; but when they belong to the same they are sometimes confounded with one another, at least in common language.... The gardener, who cultivates his own garden with his own hands, unites in his own person the three different characters, of landlord, farmer and labourer. His produce, therefore should pay him the rent of the first, the profit of the second, and the wages of the third. The whole, however, is commonly considered as the earnings of his labour. Both rent and profit are, in this case, confounded with wages. (Smith [1776] 1981, I.vi.19, 23, pp. 70-71) Similarly, Smith addresses the issue of who manages or directs the production process in his analysis of the overseer:

    Common farmers seldom employ any overseer to direct the general operations of the farm. They generally too work a good deal with their own hands, as ploughman, harrowers, etc. What remains of the crop after paying the rent,... but pay them the wages due to them as labourers and overseers. Whatever remains, however, after paying the rent and keeping up the stock, is called profit.... The farmer, by saving these wages, must necessarily gain them. Wages therefore, are in this case confounded profit. (Smith [1776] 1981, I.vi.21, p. 70) Smith acknowledges that a component of production is the effort to oversee the production process and that it should be rewarded as a component of labor. Payments can be made to a sole proprietor as income, which accounts for labor and entrepreneurial input.

    A more contemporary view of the entrepreneur's contribution is "a decision-maker whose entire role arises out of his alertness to hitherto unnoticed opportunities" (Kirzner 1973, p. 39, emphasis original). The entrepreneur clearly brings more to the production process than the elements that could be supplied by others, including managers, resource holders, and those who provide capital. These missing elements of risk-bearing and profit recognition must be compensated as well.

    We focus on the entrepreneur's basic role as the individual who organizes the inputs to produce a product through risk-bearing and profit recognition. The entrepreneur bears the risk of receiving payment for...

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