Q.Distinguish between risk and uncertainty as used in Knight's theory of profit.
Frank Knight sharpened the risk-bearing theory of profit by pointing out that everyday language uses the word "risk" for two quite different situations.
A risk, in Knight's precise sense, is a situation where the probability of different outcomes can be worked out statistically from past experience -- the chance that a particular type of factory will catch fire in a given year, for instance -- and can therefore be pooled and insured against. Once such a risk is insured, it stops being a reason for any special reward, because the insurance premium already covers it in advance.
A true uncertainty, by contrast, is a one-off, genuinely novel situation -- such as whether a brand-new product will be accepted by consumers -- whose probability simply cannot be calculated beforehand from any body of past data, and which therefore cannot be insured against at all.
Knight argued that profit is the reward specifically for bearing this second kind of non-insurable uncertainty, not for bearing ordinary, insurable risk -- and that it is exactly this function that most precisely distinguishes what an entrepreneur does from what an insured business owner does.
Risk is measurable and insurable (e.g. fire risk); uncertainty is immeasurable and non-insurable (e.g. the success of a wholly new product). Knight held that profit rewards bearing uncertainty, not risk, since insured risk no longer justifies any special reward.
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