Normal profit is an economic concept that accounts for both explicit costs (actual monetary outlays) and implicit costs (opportunity costs). A firm is said to earn a normal profit when its total revenue equals the sum of explicit and implicit costs — i.e., economic profit equals zero. Normal profit is therefore also called “zero economic profit.” (Source: Investopedia, Sydney Burns)
Why it matters
– Normal profit shows whether resources are being used as well as they could be elsewhere.
– It differs from accounting profit, which ignores implicit costs and therefore may overstate a firm’s economic performance.
– Normal profit is a useful decision rule for entry/exit, expansion, and strategic planning, and it plays a central role in competitive market theory.
Key definitions and formulas
– Accounting profit = Total revenue − Explicit costs
– Implicit costs = Opportunity costs (forgone wages, foregone rent, expected returns on capital, etc.)
– Economic profit = Total revenue − (Explicit costs + Implicit costs)
– Normal profit = The situation where Economic profit = 0, i.e., Total revenue = Explicit costs + Implicit costs
Worked example (based on the Investopedia scenario)
Suzie’s Bagels:
– Total revenue: $150,000 per year
– Explicit costs: two employees $20,000 each ($40,000) + Suzie’s salary $40,000 + rent $20,000 + supplies $30,000 = $130,000
– Implicit costs (opportunity cost of Suzie’s time): $20,000
Calculations:
– Accounting profit = $150,000 − $130,000 = $20,000
– Economic profit = $150,000 − ($130,000 + $20,000) = $0 → Normal profit
Interpretation: Suzie covers all explicit monetary outlays and earns the return she could have obtained elsewhere; she is indifferent (economically) between running the shop and pursuing the next-best alternative.
Normal profit in micro and macro contexts
– Firm/industry: Normal profit indicates resources are earning their market opportunity cost. In perfectly competitive markets, normal profit is the long-run equilibrium outcome because entry and exit drive economic profit toward zero.
– Monopoly/oligopoly: Firms with market power can earn positive economic profit (above normal profit) if barriers to entry prevent competitors from eroding returns. Governments may intervene (antitrust, regulation) to increase competition.
– Macroeconomics: Analysts can use industry-level economic profit trends to assess market health, entry incentives, or potential for structural change.
Practical steps to calculate normal profit for a business
1. Determine total (expected) revenue for the period.
2. List and sum explicit costs (wages, rent, materials, utilities, owner’s recorded salary, taxes, etc.).
3. Identify implicit costs (opportunity costs):
• Owner’s forgone salary if working elsewhere
• Foregone rental income if business uses a property the owner could rent out
• The expected return on capital invested elsewhere (e.g., percent return on alternative investments)
4. Quantify implicit costs as best as possible (see tips below).
5. Compute economic profit = Revenue − (Explicit costs + Implicit costs).
6. Interpret:
• Economic profit > 0 → Positive economic profit (above normal) — attractive to entrants.
• Economic profit = 0 → Normal profit — resources earn their opportunity cost.
• Economic profit 0: The firm earns above-normal returns — attractive for investment/entry or justification to maintain/increase scale.
– If economic profit = 0: The firm earns a normal profit — resources earn their best alternative; continuing is economically neutral.
– If economic profit < 0: The firm is not covering opportunity costs — consider exit, restructure, or seek ways to improve revenue/cut costs.
Summary
Normal profit is the benchmark that ensures all explicit and implicit costs are covered; it represents the minimum economic return required to keep resources in their current use. It complements accounting profit by incorporating opportunity costs, and it is a central tool for strategic decisions, market analysis, and understanding competitive dynamics.
Source
Investopedia, “Normal Profit” (Sydney Burns).
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.