The Microfoundations of Entrepreneurship

Abstract

Throughout the market process, economic incentives exist for individuals to exploit opportunities and earn profits. Individuals respond to such incentives, but their ability to recognize opportunities and redistribute resources in new and creative ways varies. Only those individuals with superior alertness toward possible changes and who are able to cope with disequilibrium move to reallocate resources and become entrepreneurs. Thus, the role of the entrepreneur is to discover and seize market opportunities by reorganizing economic resources in new and innovative ways. Yet, it remains to be explained how entrepreneurs choose whether or not to act upon a perceived profit opportunity. The goal of this paper is to provide a model describing the decision process followed by potential entrepreneurs who are faced with such opportunities. In other words, we build a model describing the decisional algorithm that causes some individuals to act upon the profit opportunities they perceive and others to discard them. Our claim is that individuals act rationally, process all available information, and decide to exploit or not to exploit a potential opportunity by comparing the subjective returns to becoming an entrepreneur with the subjective returns of performing any alternative income-producing activity. Individuals become entrepreneurs if, and only if, their subjective relative return to entrepreneurship is positive. In addition, we argue, subjective relative returns to entrepreneurship are influenced by the existing rate of entrepreneurial activity in the individual's vicinity.