key term - Normal Profits

Definition

Normal profits refer to the minimum level of profits a firm must earn in the long run to remain in business. They represent the opportunity cost of the firm's resources, including the owner's own time and capital invested, and are the minimum level of returns required to keep the firm operating in a given industry or market.

5 Must Know Facts For Your Next Test

1. Normal profits are the minimum level of profits a firm must earn to remain in business in the long run.
2. Normal profits include the opportunity cost of the firm's resources, such as the owner's time and capital invested.
3. If a firm earns less than normal profits, it will eventually exit the market, as it is not covering the opportunity cost of its resources.
4. In perfect competition, firms earn normal profits in the long run, as competition drives economic profits to zero.
5. The concept of normal profits is important for understanding the long-run equilibrium of firms in various market structures, such as perfect competition and monopolistic competition.

Review Questions

• Explain how normal profits differ from accounting profits and economic profits.
  • Normal profits differ from accounting profits and economic profits in that they include the opportunity cost of the firm's resources, such as the owner's time and capital invested. Accounting profits only consider the firm's explicit costs, while economic profits take into account the implicit costs of the firm's resources. Normal profits represent the minimum level of returns required for the firm to remain in business in the long run, as they cover the opportunity cost of the firm's resources.
• Describe the role of normal profits in the long-run equilibrium of a perfectly competitive market.
  • In a perfectly competitive market, firms will earn normal profits in the long run. This is because competition will drive economic profits to zero, as new firms enter the market and existing firms expand production. The only profits that remain are the normal profits, which cover the opportunity cost of the firm's resources. If a firm were to earn more than normal profits, new firms would enter the market, increasing supply and driving prices down until normal profits are restored.
• Analyze how the concept of normal profits is important for understanding the long-run behavior of firms in different market structures.
  • The concept of normal profits is crucial for understanding the long-run behavior of firms in various market structures. In perfect competition, firms earn normal profits in the long run, as competition drives economic profits to zero. In monopolistic competition, firms may earn economic profits in the short run, but these profits will be eroded by the entry of new firms in the long run, until normal profits are restored. In monopoly, firms may earn economic profits indefinitely, as the lack of competition prevents the entry of new firms. Understanding normal profits is essential for analyzing the long-run equilibrium and decision-making of firms in different market environments.

Related terms

Economic Profit:

Economic profit is the difference between a firm's total revenue and its total economic costs, including the opportunity cost of the owner's time and capital invested.

Accounting Profit:

Accounting profit is the difference between a firm's total revenue and its total accounting costs, which do not include the opportunity cost of the owner's time and capital.

Opportunity Cost:

Opportunity cost is the value of the best alternative forgone when making a decision. In the context of normal profits, it represents the minimum returns the firm's resources could earn in their next best use.