Innovation Theory of Economic Profits
An additional theory of economic profits, innovation profit theory, describes the above normal profits that arise following successful invention or modernization. For example, innovation profit theory suggests that Microsoft Corporation has earned superior rates of return because it successfully developed, introduced, and marketed the Graphical User Interface, a superior image based rather than command-based approach to computer software instructions. Microsoft has continued to earn above-normal returns as other firms scramble to offer a wide variety of “user friendly” software for personal and business applications. Only after competitors have introduced and successfully saturated the market for user-friendly software will Microsoft profits be driven down to normal levels. Similarly, McDonald’s Corporation earned above-normal rates of return as an early innovator in the fast-food business. With increased competition from Burger King, Wendy’s, and a host of national and regional competitors, McDonald’s, like Apple, IBM, Xerox, and other early innovators, has seen its above-normal returns decline. As in the case of frictional or disequilibrium profits, profits that are due to innovation are susceptible to the onslaught of competition from new and established competitors. Innovation Theory of Economic Profits.