Normal Profit

Definition

Normal profit is the minimum level of profit a firm must earn to remain in business in the long run. It represents the opportunity cost of the firm's resources, or the returns the firm's owners could earn by employing their resources elsewhere in the economy.

5 Must Know Facts For Your Next Test

1. Normal profit is the minimum level of profit a firm must earn to remain in business in the long run.
2. Normal profit represents the opportunity cost of the firm's resources, or the returns the firm's owners could earn by employing their resources elsewhere in the economy.
3. In a perfectly competitive market, firms will earn normal profit in the long run as new firms enter and existing firms exit until the market reaches equilibrium.
4. Firms that earn less than normal profit in the long run will eventually exit the market, as they are not covering their opportunity costs.
5. Firms that earn more than normal profit in the long run will attract new entrants, driving down prices and profits until they reach the normal profit level.

Review Questions

• Explain how normal profit is related to the concept of explicit and implicit costs.
  • Normal profit is the minimum level of profit a firm must earn to cover its explicit costs, such as wages, rent, and the cost of raw materials, as well as its implicit costs, which represent the opportunity cost of the firm's owned resources, such as the value of the owner's time or the use of the owner's property. The sum of a firm's explicit and implicit costs represents its total economic costs, and the firm must earn at least normal profit to remain in business in the long run.
• Describe how the concept of normal profit relates to a firm's decision-making in a perfectly competitive market.
  • In a perfectly competitive market, firms will earn normal profit in the long run as new firms enter and existing firms exit until the market reaches equilibrium. Firms that earn less than normal profit in the long run will eventually exit the market, as they are not covering their opportunity costs. Conversely, firms that earn more than normal profit in the long run will attract new entrants, driving down prices and profits until they reach the normal profit level. This ensures that in the long run, firms in a perfectly competitive market will earn only normal profit, as any economic profit above that level will be competed away.
• Analyze how the concept of normal profit influences a firm's entry and exit decisions in the long run.
  • The concept of normal profit is a key factor in a firm's long-run entry and exit decisions. Firms that are able to earn more than normal profit in the long run will attract new entrants, as the potential for above-average returns will incentivize other firms to join the market. Conversely, firms that are unable to earn at least normal profit in the long run will eventually exit the market, as they are not covering their opportunity costs and cannot remain viable. This process of entry and exit continues until the market reaches a long-run equilibrium where all firms are earning only normal profit, the minimum level required to stay in business. The concept of normal profit, therefore, is a critical consideration for firms as they evaluate the long-term sustainability of their operations.

Related terms

Explicit Costs:

Explicit costs are the out-of-pocket expenses a firm incurs, such as wages, rent, and the cost of raw materials.

Implicit Costs:

Implicit costs are the opportunity costs of the firm's owned resources, such as the value of the owner's time or the use of the owner's property.

Economic Profit:

Economic profit is the difference between a firm's total revenue and its total economic costs, including both explicit and implicit costs.