Risk and uncertainty

The distinction between the two is that risk denotes a positive probability of something bad happening, while uncertainty does not necessarily imply a value judgment or ranking of the possible outcomes. Fundamentally, though, in common usage both terms refer to a similar situation, in which some aspect of the future cannot be foreseen.


Frank H. Knight established the economic definition of the terms in his landmark book, Risk, Uncertainty, and Profit (1921):
risk is present when future events occur with measurable probability
uncertainty is present when the likelihood of future events is indefinite or incalculable

The primary attribute of competition, universally recognized and evident at a glance, is the "tendency" to eliminate profit or loss, and bring the value of economic goods to equality with their cost.... But in actual society, cost and value only "tend" to equality; it is only by an occasional accident that they are precisely equal in fact; they are usually separated by a margin of "profit," positive or negative. Hence the problem of profit is one way of looking at the problem of the contrast between perfect competition and actual competition.

Theories of profit developed prior to Knight argued that profit arises because people do not have perfect knowledge about the future. Whenever anything happens to make the outcome of events not match with people's expectations, then the revenues ("values" in the above quote) from the goods or services they produce will not equal costs, and profit will occur.

Uncertainty, which cannot be eliminated or insured against, is for Knight the source of profit.