Entrepreneurship , Innovation , and Dynamic Growth vs . Instability in the Market

The challenge of the current study is to introduce entrepreneurship into Microeconomics theory for greater extendability and realism yet capture its unique aspects in a manageable analytical model. The model starts with a perfectly competitive market and then adds a subset of agents with unique skills, capabilities, startup savings, and risk preferences, called entrepreneurs. These profit-seeking agents, raising funds from the financial markets, modify a fraction of the existing products with additional (close substitute) attributes. Thus, a situation of monopolistic competition is created. A unique contribution developed is that entrepreneurship creates an endogenous cycle which brings growth but also instability and inequality at the same time caused by the risky decisions an entrepreneur has made before. The expected profit motive drives entrepreneurs to create new products, which expands supply. In perfect competition, markets' price competition erodes entrepreneurs’ monopoly rents to zero with a new equilibrium. However, in the current model, entrepreneurs simultaneously change the structure of the market toward monopolistic competition, creating a dynamic cycle where the prospect of entrepreneurial rents drives more product innovation, supply to the market, and structural change; while, at the same time, higher profit rates induce entry and price-cutting and force out old capacity and products.