F. B. Hawley offered his risk theory of profit in 1893. According to Hawley,

risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environm ...

in business arose from product

obsolescence Obsolescence is the state of being which occurs when an object, service, or practice is no longer maintained or required even though it may still be in good working order. It usually happens when something that is more efficient or less risky r ...

, a sudden fall in prices, superior substitutes, natural calamities, or scarcity of certain crucial materials.

Background

Risk taking was an inevitable component of dynamic

production Production may refer to: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products (goods and services) * Production as a stati ...

, and those who took risk in business had a right to a separate reward known as " profit". According to Hawley, profit is the price by society for assuming

business risk The term business risks refers to the possibility of a commercial business making inadequate profits (or even losses) due to uncertainties - for example: changes in tastes, changing preferences of consumers, strikes, increased competition, changes ...

. A businessman would not take a risk without expecting compensation in excess of actuarial value- i.e., a premium on calculable risk. The reason that expected profit must be more than actuarial risk is the assumption that risk gives rise to dis-utilities of various kinds. Therefore, assuming risk gives the

entrepreneur Entrepreneurship is the creation or extraction of economic value. With this definition, entrepreneurship is viewed as change, generally entailing risk beyond what is normally encountered in starting a business, which may include other values t ...

a claim to a

reward Reward may refer to: Places * Reward (Shelltown, Maryland), a historic home in Shelltown Maryland * Reward, California (disambiguation) * Reward-Tilden's Farm, a historic home in Chestertown Maryland Arts, entertainment, and media * "Rewa ...

in excess of the actuarial value of the risk. Hawley stated that profit was composed of two parts: one part represents compensation for average

loss Loss may refer to: Arts, entertainment, and media Music * ''Loss'' (Bass Communion album) (2006) * ''Loss'' (Mull Historical Society album) (2001) *"Loss", a song by God Is an Astronaut from their self-titled album (2008) * Losses "(Lil Tjay son ...

incidental to the various causes of risk, and the other part represents an inducement to suffer the

consequence Consequence may refer to: * Logical consequence, also known as a ''consequence relation'', or ''entailment'' * In operant conditioning, a result of some behavior * Consequentialism, a theory in philosophy in which the morality of an act is determi ...

s of being exposed to the risk. Hawley believed that profits arose from the factor of ownership, as long as the ownership included risks. If the entrepreneur avoided iskby

insuring Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to hedge ...

against it, he ceased to be an entrepreneur and should not receive profits. According to Hawley, profit arose out of uninsured risk. The uncertainty ends with sale of the entrepreneur's product. Profit thus is a residue. Hawley's theory is also known as the "residual theory of profit"

References

External links

{{cite document, ssrn=1506384 , title=The Risk Theory of Profit by Frederick B. Hawley :: SSRN , publisher=Papers.ssrn.com , date=2009-11-17 , last1=Hawley , first1=Frederick B. Risk analysis Business economics