Entrepreneurship and Innovation
We have now addressed the basic requirements of production—acquiring land, labor, physical and human capital, and finding financial capital to pay for it. Is that all that is required to operate a business? Not quite. Recall from Chapter 2 that the factors of production are land, labor, capital, and entrepreneurship.
What is entrepreneurship? Entrepreneurship is the willingness to take risks and to use ideas to convert physical inputs into final products that are appealing to consumers. One can argue that entrepreneurship is the most essential factor of production—without a great idea on how to use resources, the final products will likely be of little value or may not even be produced.
Entrepreneurship
Profits are the rewards entrepreneurs receive for (1) combining land, labor, and capital to produce goods and services, and (2) assuming the risks associated with producing these goods and services. Entrepreneurs must combine and manage all the inputs of production; make day-to-day production, finance, and marketing decisions; innovate constantly if they hope to remain in business over the long run; and simultaneously bear the risks of failure and bankruptcy.
As we have seen over the past decade, large firms that have become household names can implode quickly. Lehman Brothers, Circuit City, Blockbuster Video, and Borders are a few companies that have either closed or filed for bankruptcy protection.
Even for large firms, business is risky. Bankruptcy or business failure, meanwhile, can be exceedingly painful for business owners, stockholders, employees, and communities. Still, a free economy requires such failures. If firms were guaranteed never to fail, perhaps through government subsidies (bailouts), they would have little incentive to be efficient or to innovate, or to worry about what consumers want from them.
When a firm earns economic profits—profits exceeding normal profits—this is a signal to other firms and entrepreneurs that consumers want more of the good or service the profitable firm provides, and that they are willing to pay for it. Profit signals shift resources from areas of lower demand to the products and services consumers desire more highly. It is entrepreneurs who are attuned to the profit signals.
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Innovation and the Global Economy
Innovation describes both entrepreneurship, when individuals and firms develop something new, and the constant retooling of existing products. Innovation arguably is the most productive input in the production process. Many countries, such as those in Africa, have abundant natural resources and labor, yet have not been able to convert those inputs into substantial outputs. Meanwhile, such countries as Japan, Germany, and Sweden, with more limited physical resources, have compensated by generating high levels of human capital and innovation, and subsequently generate a very high standard of living for their citizens.
intellectual property rights A set of exclusive rights granted to a creator of an invention or creative work, allowing the owner to earn profits over a fixed period of time. The types of protection include patents, copyrights, trademarks, and industrial designs.
An important issue is that to encourage innovation, those who innovate must be provided with incentives to make the money and effort invested worthwhile. For example, an individual’s or a firm’s innovations can be protected using intellectual property rights, including patents, copyrights, trademarks, and industrial designs, allowing innovators an exclusive right to earn profits from their investments for a fixed amount of time.
The importance of innovation as a driver of economic growth will continue to increase as the economy becomes more globalized. Specifically, deficiencies in physical capital can easily be resolved through trade and foreign direct investment. But deficiencies in human capital and innovation are a much more difficult obstacle to overcome.
Therefore, the future of a country’s economic growth will depend on its ability to generate new ideas and find more productive uses of its limited resources. At the start of this chapter, we discussed the aerospace industry and its goals of developing planes that provide more comfort to passengers, and reduce operating costs. Both objectives increase the productive use of limited resources, which will allow the industry to grow as people demand more travel.
But advances in innovative technology cannot be limited to just a few industries. All industries must avoid falling behind the trend of increasing productivity throughout the world. Emerging countries have begun to invest significant sums to improve physical infrastructure and human capital. This had led to innovations in all industries and an improvement in the standards of living in these countries. In order for the United States to continue increasing its standard of living, it must maintain its position as a leader in innovation.
ENTREPRENEURSHIP AND INNOVATION
- Entrepreneurs earn profits for combining other inputs to create products and for assuming the risks of producing goods and services.
- Innovation includes the efforts by entrepreneurs to produce new products as well as efforts by firms to make existing products better.
- Entrepreneurship and innovation is arguably the most productive of the factors of production, allowing countries to use limited resources to produce valuable outputs that lead to a higher standard of living.
QUESTION: Why is entrepreneurship considered a factor of production despite the fact that it does not exist in physical form? Suppose a country has abundant amounts of natural resources and labor, would this automatically translate into a highly productive economy?
Entrepreneurship is the idea and vision to turn physical inputs such as land, labor, and capital into valuable outputs that people demand. An economy cannot produce goods without someone willing and able to determine what the market wants. Therefore, entrepreneurship is a vital factor of production.
Although having abundant amounts of natural resources and labor may provide a country with an advantage in production, a country still requires entrepreneurship to turn those physical inputs into valuable products people desire. Thus, having abundant physical inputs does not automatically result in a productive economy. The reverse is also true—having few physical inputs does not preclude a country from being productive if it is able to use its limited resources effectively.
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