Normal Profit: The Invisible Threshold of Business
1. What Exactly is Normal Profit? A Simple Lemonade Stand View
Imagine you run a lemonade stand. At the end of the day, you count your money. You spent $10 on lemons and sugar, and you sold $15 worth of lemonade. Your accounting profit is $5. But what if your friend offered you $8 to wash dishes instead? By running the stand, you gave up that $8. That lost opportunity is an implicit cost. Normal profit is the $8 you could have earned elsewhere. To stay in the lemonade business, you need to cover your $10 costs plus that $8 opportunity cost. If you only make $15, you are actually earning less than normal profit and should consider washing dishes instead.
2. Normal vs. Economic vs. Accounting Profit
These three terms often confuse students. The table below breaks down the differences using a simple story of a bakery.
| Type of Profit | Formula | Bakery Example |
|---|---|---|
| Accounting Profit | Total Revenue – Explicit Costs | Revenue $100,000 – Flour, sugar, rent $70,000 = $30,000 |
| Economic Profit | Total Revenue – (Explicit Costs + Implicit Costs) | $100,000 – ($70,000 + $25,000 foregone salary) = $5,000 |
| Normal Profit | Economic Profit = $0 (Breakeven point) | When revenue exactly covers explicit $70,000 + implicit $25,000 = $95,000. |
🍕 Real-World Scenario: The Pizza Shop Decision
Maria owns a small pizza shop. Last year, her accounting profit was $50,000. However, she used to work as a manager earning $45,000 a year, and she invested $100,000 of her savings that could have earned $5,000 in interest. Her implicit costs are $45,000 + $5,000 = $50,000. Her economic profit is $50,000 – $50,000 = $0. This means she is earning exactly normal profit. She is not losing money, but she is also not gaining extra beyond what she could get elsewhere. This helps her decide: stay in pizza or go back to managing? If she earned $55,000 accounting profit (economic profit $5,000), she would be earning above-normal profit and would definitely stay.
❓ Important Questions About Normal Profit
A: Not in the everyday sense. In economics, normal profit is considered a cost (the opportunity cost of the entrepreneur). It is the minimum amount required to keep resources in their current use. If a firm earns less than normal profit, it will eventually leave the industry.
Q2: Can normal profit be shown in a formula?
A: Yes. In economics, we say a firm earns normal profit when:
Or when Economic Profit = $0.
A: That is called economic (or supernormal) profit. It signals other entrepreneurs to enter the market, increasing competition. In the long run, this usually drives profits back down to normal profit level.
🎯 Conclusion: The Hidden Compass of Business
📚 Footnote
[1] Opportunity Cost: The value of the next best alternative that is given up when making a choice. For example, the salary you forgo to start a business.
[2] Explicit Costs: Direct, out-of-pocket payments like rent, wages, and materials.
[3] Implicit Costs: Indirect, non-monetary costs such as the owner's time or the interest money could have earned elsewhere.
[4] Economic Profit: Total revenue minus total costs (explicit + implicit). When it is zero, the firm earns normal profit.