Normal Profit

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What is Normal Profit?

Normal Profit is an economic term that when the profit is zero after considering both the implicit cost and the direct cost and the overall opportunity costs. It occurs when all the resources are efficiently utilized and cannot be used for a better purpose. If the residual gain is non-zero, then it is called supernormal profit.

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  • Normal profit is an economic term referring to zero profit after considering both implicit and explicit costs, including opportunity costs. It signifies efficient resource allocation, where no alternative use of resources can yield greater returns. If there is any profit above zero, it becomes a supernormal profit.
  • Normal profit is linked to economic profit in a company or industry. A zero economic profit indicates an ideal situation in a perfectly competitive industry.
  • Negative economic profit may lead to excessive competition, causing some firms to incur unmanageable losses and eventually wind up, bringing the profit back to zero.

Normal vs Economic Profit

Economic Profit

It is said to occur when the firm earns from the revenue after accounting for explicit cost and implicit costs.

Economic Profit = Total Revenue – Implicit costs – Explicit Costs

Normal Profit

However, it is said to have occurred when economic profit is zero or in other words, the revenue is equal to implicit cost and explicit costs.

Total Revenue – (Implicit Costs + Explicit Costs) = 0

Or Total Revenue = Implicit Costs + Explicit Costs

  • Implicit cost is also called as the opportunity cost of a particular enterprise. It is not easily quantifiable.
  • Explicit costs are easily quantifiable as it denotes the actual expenses made by the firm towards raw material, labor wages, rent, owner remuneration, and other expenses for running the business.
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Example of Normal Profit

Consider Elvis running a corporation with a revenue of $100,000. He has to pay rent for the office at $25,000, and the staff's wages and other office expenses equal $ 40,000. He met with an expert who assumes that the time and capital spent by Elvis should be equal to $ 35,000 annually.

Calculation of Total Cost

Normal Profit Example 1

Here, the total costs (including the opportunity costs) = 25000 + 40000 + 35000 = 100,000

Thus, total costs = total revenue

Hence, the firm can be said to working at a normal profit.

Normal Profit in Macro Economics

When an industry is said to be earning a normal profit, it is considered that the industry is in a state of perfect competition. All the resources are utilized efficiently. Further, there is no economic profit in the industry.

It can be considered an ideal situation for both the producers and the consumers. The consumers receive goods at competitive prices, and all the goods produced by the producers are consumed.

However, whenever an industry has an economic profit, more entrepreneurs and firms will enter the industry, thus raising competition and putting price pressures. It makes the industry highly competitive and will reach a stage of normal profit.

The above concept can be reversed in case the industry has economic losses. The companies will tend to close down and leave the industry because there is no profit. The industry will remain with few companies, thus reaching a state of normal profit.

Advantages 

  • Firms can use it to compare their business performance and profit with businesses in other sectors and learn about opportunity costs.It can be used in macroeconomics to understand various sectors if they are declining or improving.
  • It can be used to determine if an industry is moving towards monopoly or oligopoly thus helping in better governance and legislation to improve competition in the industry.

Disadvantages and Limitations

It includes the opportunity cost of the firm. This opportunity cost is difficult to measure since it is a subjective measure. If the opportunity cost is not measured accurately or by taking appropriate assumptions, the calculation of normal profit may lead to different and wrong decisions. This limitation is also a disadvantage of using this measure since it may lead to bad decision-making.

Important Points

It is linked to the economic profit of the company or industry. If it is zero, then it is considered the ideal situation of perfect competition in the industry. However, if this profit changes positive to negative, then:

  • More firms will open up in the same industry if it is positive to earn money. It will lead to more competition in the industry and decrease profit.
  • If it is negative, too many firms are competing in the industry, and some will close down due to unbearable losses. It will make the profit zero.

Conclusion

Normal profit is said to occur when the company earns revenue equal to the implicit and explicit cost of the company. It includes the opportunity costs of the company. The situation in macroeconomics occurs when the industry experiences perfect competition. In such a scenario the economic profit of the firm is zero.

Frequently Asked Questions (FAQs)

1. What is normal profit and supernormal profit? 

Normal profit refers to the minimum level of profit required to keep a business in operation, covering both explicit and implicit costs. On the other hand, Supernormal profit is the excess profit earned by a business above and beyond the normal profit level.

2. What is normal profit also known as? 

Normal profit is also known as "break-even profit" or "zero economic profit." It denotes the point at which a business generates just enough profit to cover all costs, including opportunity costs, without earning any additional economic profit.

3. Why is normal profit a cost? 

Normal profit is considered a cost because it represents the opportunity cost of using resources in a particular business instead of pursuing alternative opportunities. It includes both explicit costs (actual expenses) and implicit costs (opportunity costs) and is essential for a business to continue operating in the long run. Without normal profit, a business may not be sustainable in the market.