Normal Profit

Key takeaways

• Normal profit occurs when a firm’s economic profit is zero: total revenue equals the sum of explicit and implicit costs.
• It differs from accounting profit because it includes implicit (opportunity) costs.
• A firm can report a positive accounting profit yet still be at normal profit if opportunity costs absorb that profit.
• In perfect competition, industries are expected to earn normal profit in equilibrium; monopolies can sustain positive economic profit.

What is normal profit?

Normal profit is the minimum return a business must earn to justify keeping resources in their current use, accounting for both explicit and implicit costs. It is also called zero economic profit because economic profit equals zero in this state.

Relationship to economic and accounting profit

• Economic profit = Total revenue − Explicit costs − Implicit costs
• Normal profit occurs when economic profit = 0, so:
  Total revenue = Explicit costs + Implicit costs

Accounting profit only subtracts explicit costs (the actual out-of-pocket expenses recorded on financial statements). Implicit costs—such as foregone wages, rental income, or alternative investment returns—are not recorded on the books but are crucial to economic and normal profit calculations.

Explicit vs. implicit costs

• Explicit costs: directly paid, easily quantifiable (e.g., wages, rent, materials, owner salary).
• Implicit costs: opportunity costs of resources owned or used by the firm (e.g., a proprietor’s foregone salary, rental income not collected because property is used for the business, lost return on invested capital).

How to calculate normal profit (steps)

1. Sum all explicit costs.
2. Estimate implicit costs (opportunity costs).
3. Add them to get total economic cost.
4. Compare total revenue to total economic cost: if equal, the firm is at normal profit.

Example

Suzie’s Bagels:
– Annual revenue: $150,000
– Explicit costs: two employees ($20,000 each), Suzie’s salary ($40,000), rent ($20,000), supplies ($30,000) → total explicit = $130,000
– Implicit cost (foregone alternative income): $20,000
– Total economic cost = $130,000 + $20,000 = $150,000
Because total revenue equals total economic cost, Suzie’s Bagels is earning normal profit (economic profit = 0), even though accounting profit before taxes is $20,000.

Macroeconomic context

• Under perfect competition and equilibrium, firms in an industry tend toward normal profit: positive economic profits attract entry, increasing supply and lowering prices until profits normalize; losses encourage exit until remaining firms return to normal profit.
• Monopolies or markets with high barriers to entry can sustain positive economic profits because entry is restricted. Governments may use antitrust policy to increase competition where monopoly power persists.

Applications

• Business decision-making: comparing potential projects or expansions by including opportunity costs to see if returns exceed what could be earned elsewhere.
• Industry analysis: economists use normal and economic profit measures to assess whether a market is competitive, attracting entry, or dominated by a few firms.

Special considerations

• Implicit costs are estimates and can be difficult to measure accurately, which affects the precision of normal profit calculations.
• Normal profit does not imply the firm is not making money in accounting terms—rather, it means resources earn no more than their next best alternative.