RISK

RISK IS THE PROBABLE MEASUREMENT OF UNCERTAINTY. WHEN UNCERTAINTY IS REDUCED TO A NUMBER

OF POSSIBLE RESULTS TO ALTERNATIVE COURSES OF ACTION, IT IS CALLED RISK. THUS, RISK IS A STATE OF
KNOWLEDGE IN WHICH THE RESULT OF EVERY ALTERNATIVE IS EXPECTED TO BE ONE OF THE CERTAIN
POSSIBLE RESULTS. THE DECISION-MAKER CAN CALCULATE THE POSSIBILITY OF ALL THE DECISIONS. THE
TERM RISK HAS BEEN DEFINED AS UNDER:
MILTON H. SPENCER, “RISK HAS BEEN DEFINED AS A STATE OF KNOWLEDGE IN WHICH EACH ALTERNATIVE
LEADS TO ONE OF A SET OF SPECIFIC OUTCOMES, EACH OCCURRING WITH A PROBABILITY THAT IS KNOWN
TO THE DECISION-MAKER.”
MEASUREMENT OF POSSIBILITY OF RISK

THERE ARE TWO METHODS OF MEASURING PROBABILITY OF RISK-

1. PRIORI PRINCIPLE OR DEDUCTION METHOD
2. POSTERIORI PRINCIPLE OR PAST EXPERIENCE METHOD
PRIORI PRINCIPLE OR DEDUCTION METHOD

UNDER THIS METHOD OF MEASURING THE PROBABILITY OR RISK, THE PROBABILITY OF RISK IS MEASURED
ON THE BASIS OF IMAGINARY PRINCIPLES. NO PAST EXPERIENCE IS USED FOR HELP UNDER THIS METHOD.
FOR EXAMPLE, IF A FIRM IS ENGAGED IN ILLEGAL BUSINESS, IT IS ALL THE TIMES POSSIBLE THAT IT WILL
COME TO LIGHT AND BE PUNISHED SOONER OR LATER. IT IS ALWAYS POSSIBLE TO LOOSE IN THE
TRANSACTIONS OF SPECULATION
POSTERIORI PRINCIPLE OR PAST
EXPERIENCE METHOD

ACCORDING TO THIS PRINCIPLE OF MEASURING PROBABILITY OR RISK, HELP OF PAST EXPERIENCES IS

TAKEN TO MEASURE THE PROBABILITY OF RISK. THIS PRINCIPLE IS BASED UPON THE ASSUMPTION THAT
‘HISTORY REPEATS ITSELF.
TYPES OF RISKS
• BUSINESS RISK: BUSINESS RISKS ARE THE RISKS WHICH ARE RELATED WITH THE PRODUCTION, MARKETING AND
PERSONNEL AFFAIRS OF A BUSINESS FIRM. A FIRM HAS TO FACE THE RISKS AT EVERY STEP SUCH AS- TASTES AND
PREFERENCES OF CUSTOMERS, POLICIES OF COMPETITORS, QUALITY AND PRICE OF THE PRODUCTS OF
COMPETITORS, BUSINESS CYCLES, LABOR STRIKES, PRICING POLICY OF THE FIRM ETC. WHEN UNCERTAINTY IN
THIS REGARD IS MEASURABLE, IT BECOMES BUSINESS RISK.
• FINANCIAL RISK: FINANCIAL RISKS ARE THE RISKS RELATED WITH FINANCIAL ACTIVITIES AND DECISIONS OF A
FIRM. FINANCIAL DECISIONS DETERMINE THE FINANCIAL RISK OF A FIRM. FINANCIAL RISKS RELATE TO THE RISK
OF POSSIBLE FLUCTUATIONS IN THE PROFIT, RISK OF BAD DEBTS AND THE RISK OF POSSIBLE INSOLVENCY ETC.
EFFECT OF FINANCIAL RISKS IS REFLECTED IN THE PRICES OF SHARES.
• PORTFOLIO RISK: PORTFOLIO RISKS ARE THE RISKS THAT ARE DERIVED FROM VARIOUS INVESTMENT PROPOSALS
AND THEIR EFFECT ON THE FINANCIAL STRUCTURE OF A FIRM. SUCH RISKS ARE INSURABLE.
UNCERTAINTY
UNCERTAINTY IS JUST OPPOSITE TO THE SITUATION OF CERTAINTY. UNCERTAINTY IS A SITUATION IN
WHICH THE RESULT OF VARIOUS DECISIONS CANNOT BE PREDICTED AND THEIR PROBABILITY CAN ALSO
NOT BE MEASURED. THE TERM UNCERTAINTY HAS BEEN DEFINED AS UNDER:
“UNCERTAINTY HAS BEEN DEFINED AS A STATE OF KNOWLEDGE IN WHICH ONE OR MORE ALTERNATIVES
RESULT IN A SET OF SPECIFIC OUTCOMES BUT WHERE THE PROBABILITIES OF THE OUTCOMES ARE NEITHER
KNOWN NOR MEANINGFUL.”
KINDS OF UNCERTAINTY

A LARGE NUMBER OF DECISIONS ARE TAKEN IN EVERY BUSINESS FIRM ON VARIOUS ISSUES. ALL THE
IMPORTANT DECISIONS OF A FIRM ARE TAKEN BY MANAGEMENT WITH THE ADVICE OF MANAGERIAL
ECONOMIST. SUCCESS OF A FIRM DEPENDS TO A LARGE EXTENT UPON THE EFFECTIVENESS OF THESE
DECISIONS. HOWEVER, ALL THE DECISIONS ARE TAKEN IN AN ATMOSPHERE OF UNCERTAINTY. THEREFORE, IT
BECOMES NECESSARY TO UNDERSTAND THE TYPES AND VARIOUS AREAS OF UNCERTAINTY IN WHICH
MANAGEMENT OF A BUSINESS FIRM HAS TO TAKE DECISIONS. MAIN AREAS OF UNCERTAINTY ARE AS
FOLLOWS:
• DEMAND UNCERTAINTY: THE FIRST AND THE MOST IMPORTANT UNCERTAINTY FACED BY MANAGEMENT IN THE
PROCESS OF DECISION-MAKING IS THE UNCERTAINTY REGARDING DEMAND OF THE PRODUCTS OF THE FIRM.
FORECASTING OF THE DEMAND IS ESSENTIAL TO TAKE DECISIONS REGARDING PRODUCTION, COST OF
PRODUCTION, CAPITAL REQUIREMENTS ETC. MANAGEMENT PREPARES A DEMAND TABLE AND ANALYSES IT BUT
THAT ALL IS DONE UNDER UNCERTAINTY AND IS SIMPLE A GUESS.
• PRODUCTION UNCERTAINTY: SECOND MOST IMPORTANT UNCERTAINTY TO BE FACED BY MANAGEMENT IS
REGARDING PRODUCTION. WHAT SHOULD BE THE QUANTITY OF PRODUCTION ? WHAT SHOULD BE THE
PRODUCTION SCHEDULE? WHAT RESOURCES SHOULD BE EMPLOYED IN PRODUCTION PROCESS ? HOW SHOULD
THESE RESOURCES BE ALLOCATED TO DIFFERENT PRODUCTION ACTIVITIES ? ETC., ARE THE QUESTIONS THAT
CREATE AN ATMOSPHERE OF UNCERTAINTY IN THE PROCESS OF DECISION-MAKING.
• PROFIT UNCERTAINTY: AS ALREADY DISCUSSED, MAIN OBJECT OF EVERY BUSINESS FIRM IS TO EARN MAXIMUM
PROFIT. PROFIT IS THE DIFFERENCE BETWEEN COST AND REVENUE. BOTH THE COST AND REVENUE ARE UNCERTAIN.
THEREFORE, WHAT WILL BE THE PROFIT OF FIRM, IS ALSO UNCERTAIN.
• PRICE UNCERTAINTY: DETERMINATION OF PRICE FOR A PRODUCT OF THE FIRM IS THE MOST IMPORTANT ASPECT OF
DECISION-MAKING PROCESS. SUCCESS OF A BUSINESS FIRM DEPENDS TO A LARGE EXTENT UPON THIS DECISION, BUT
PRICING DECISION IS AFFECTED BY A LARGE NUMBER OF EXTERNAL FACTORS OVER WHICH THE MANANGEMENT CAN
HAVE NO CONTROL. THEREFORE, THERE IS AN ELEMENT OF UNCERTAINTY IN PRICING DECISION.
• COST UNCERTAINTY: COST OF PRODUCTION IS IMPORTANT FACTOR FOR DEMANDING THE PRICE OF THE PRODUCTS OF
A FIRM. IT IS ALSO IMPORTANT FOR DETERMINING PROFIT OF THE FIRM. GENERALLY, THE COST ESTIMATES ARE BASED
UPON THE HISTORICAL COST DATA AVAILABLE FROM THE RECORDS OF A FIRM. DIFFERENT ELEMENTS OF COST ARE
ALWAYS UNCERTAIN. THEREFORE, THE ELEMENT OF UNCERTAINTY EXISTS IN THIS REGARD ALSO.
• LABOR UNCERTAINTY: LABOR IS THE FORCE THAT CONVERT ALL THE DECISIONS AND PLANS OF A FIRM INTO ACTIONS.
REGULAR SUPPLY AND EFFICIENCY OF LABOR ARE THE FACTORS THAT DETERMINE SUCCESS OF A FIRM. IF THE
MANAGEMENT FACES A PROBLEM IN GETTING REQUIRED LABOR FORCE AT REQUIRED TIME OR IF THE WORKERS DO NOT
CO-OPERATE IN THE ACCOMPLISHMENT OF ORGANIZATIONAL OBJECTIVES THE FIRM CANNOT BE SUCCESSFUL. BUT THE
SUPPLY AND EFFICIENCY OF LABOR ARE ALWAYS UNCERTAIN.
• CAPITAL UNCERTAINTY: THERE ARE MANY UNCERTAINTIES IN THE FIELD OF CAPITAL ALSO OF A BUSINESS
FIRM BECAUSE CAPITAL MARKET IS AFFECTED BY MANY ECONOMICAL AND POLITICAL FACTORS.
• ENVIRONMENTAL UNCERTAINTY: DECISIONS OF A BUSINESS FIRM ARE EFFECTED BY MANY
ENVIRONMENTAL FACTORS ALSO. SOCIAL, ECONOMICAL AND POLITICAL CIRCUMSTANCES IN WHICH THE
FIRM IS OPERATING AFFECT THE PROCESS OF DECISION-MAKING OF A FIRM BUT IT IS NEVER CERTAIN TO
PREDICT THESE FACTORS SUCCESSFULLY
 BASIS FOR COMPARISON RISK UNCERTAINTY

Meaning The probability of winning Uncertainty implies a

or losing something situation where the future
worthy is known as risk. events are not known.

Ascertainment It can be measured It cannot be measured.

Outcome Chances of outcomes are The outcome is unknown.

known.

Control Controllable Uncontrollable

Minimization Yes No
Probabilities Assigned Not assigned