What is the alertness theory of entrepreneurship?
Israel Kirzner is a British-American economist and emeritus professor at New York University. He is associated with the Austrian school of economics. Below, we review Kirzner’s alertness theory of entrepreneurship.
Kirzner argues that entrepreneurs balance supply and demand by detecting market imperfections and exploiting them. Market imperfections are caused by information asymmetry and bounded rationality.
Information asymmetry refers to cases where different stakeholders have varying information about a business venture. If one stakeholder uses the information advantage to profit from the another, it is engaging in opportunistic bargaining.
Bounded rationality refers to the idea that human are not perfectly rational. Neo-classical and Classical economics model the assumptions of economic man, and tend to ignore bounded rationality.
According to Kirzner, the profits entrepreneurs receive from entrepreneurship are their reward for their tolerance of uncertainty as they eliminate arbitrage opportunities (the opportunity to sell the same product at a higher price than he or she bought it) created by the ignorance or incompetence of incumbent firms. Entrepreneurs need to be alert in order to be able to perceive economic opportunities that others cannot yet see, such as the need for new goods or services.
Opportunities are seen to exist only because of the ignorance of incumbents otherwise they would already be exploited. When incumbents do not know key information or do not even realize what they do not know, then opportunities for entrepreneurship are born. Ignorance begets errors that can be corrected by the actions of entrepreneurs. The entrepreneur acts under uncertainty and cannot know if his or her action will yield a profit until after the action has been taken. Thus, entrepreneurs must accept they may lose money (or that of their investors) from their actions if they turn out to be incorrect.
Kirzner believes that entrepreneurial alertness cannot be taught. However, this belief has been critiqued because market research can clearly help to recognize certain types of opportunities. But a rebuttal might be that knowing that market research was needed in the first place is entrepreneurial. Kirzner does not view the economic actions such as buying resources or creating new products as entrepreneurial. Rather it is only the act of alertness that is entrepreneurial.