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What is Normal Profit?
Normal profit represents the minimum level of earnings required for a business to remain operational in the long run. It occurs when total revenue equals total costs—including both explicit costs (wages, rent, materials) and implicit costs (opportunity costs of capital and time). In economic terms, a firm earns zero economic profit but still covers all its costs, meaning there is no incentive to leave or enter the industry.
Definition
Normal profit is the level of profit that occurs when total revenue equals total economic costs (explicit + implicit), resulting in zero economic profit but sufficient earnings to keep a firm operating.
Key takeaways
- Zero economic profit: Normal profit occurs when economic profit = 0.
- Covers all costs: Both accounting and opportunity costs are fully covered.
- Long-run equilibrium: Firms in competitive markets tend toward normal profit over time.
- No incentive to exit or enter: Earnings are adequate but not excessive.
- Different from accounting profit: Accounting profit may be positive even when economic profit is zero.
How normal profit works
Normal profit reflects the idea that:
- Firms must earn enough to justify the use of their resources.
- In competitive markets, excessive profits attract new entrants.
- Entry increases supply and reduces prices until only normal profit remains.
Economic profit vs. accounting profit
| Metric | Includes | Outcome |
|---|---|---|
| Accounting profit | Explicit costs only | May appear positive |
| Economic profit | Explicit + implicit costs | Zero at normal profit |
Formula
Economic profit:
Economic Profit = Total Revenue – (Explicit Costs + Implicit Costs)
Normal Profit occurs when Economic Profit = 0
Why normal profit matters
For businesses:
- Ensures sustainability in competitive markets.
- Helps evaluate whether staying in an industry is worthwhile.
- Indicates long-term viability and resource efficiency.
For economists:
- Demonstrates competitive market equilibrium.
- Helps analyze industry entry and exit dynamics.
For investors:
- Helps identify industries where long-term abnormal profits are unlikely due to competition.
Examples of normal profit
- Small retail shops: Often earn normal profit due to intense competition.
- Agriculture: Highly competitive markets push farmers toward normal profit.
- Restaurants and cafes: Popular but highly competitive; long-run profits gravitate toward normal levels.
Normal profit in different market structures
Perfect competition
- Firms earn normal profit in the long run.
Monopolistic competition
- Differentiation allows short-term economic profit, but long-term profit returns to normal.
Monopoly
- Can earn economic profit indefinitely due to barriers to entry.
How firms assess normal profit
- Compare industry averages.
- Evaluate opportunity costs of capital and labour.
- Use long-term financial modelling.
Related concepts
- Economic profit
- Accounting profit
- Opportunity cost
- Competitive markets
- Long-run equilibrium
Sources
- OECD Economic Analysis: https://www.oecd.org/
- Investopedia – Normal profit: https://www.investopedia.com/
- Khan Academy – Market structures and profit: https://www.khanacademy.org/
Frequently Asked Questions (FAQ)
1. Is normal profit a good result?
Yes. It means the firm is sustainable and covering all costs, including opportunity costs.
2. Can a firm survive without normal profit?
Not in the long run. Without covering opportunity costs, resources may be better used elsewhere.
3. Why is normal profit considered zero economic profit?
Because all costs—including opportunity costs—are fully accounted for.
4. Do monopolies earn normal profit?
Not typically. They often earn above-normal profits due to market power.
5. Is accounting profit the same as normal profit?
No. Accounting profit excludes opportunity costs and may remain positive even when economic profit is zero.
