Supernormal profit: Profit above the normal level earned in the long run.
What is Normal Profit vs. Supernormal Profit?
To understand supernormal profit, we first need to understand normal profit. Normal profit is the minimum amount of profit required for a firm to stay in business. It is considered an opportunity cost—the income the entrepreneur could have earned elsewhere. Think of it as the "break-even" point where all costs, including the owner's time and invested money, are covered.
Supernormal profit (also called economic profit or abnormal profit) is any profit earned above this normal level. It's the "extra" reward. For example, imagine you run a small bakery. If your total revenue is $100,000 a year, and your explicit costs (flour, rent, wages) are $70,000, your accounting profit is $30,000. But if you could have earned $40,000 working as a manager at another company, your normal profit is $40,000. In this case, you are actually making a loss in economic terms, not a supernormal profit.
If your accounting profit was $60,000, then your supernormal profit would be $60,000 - $40,000 = $20,000. This extra $20,000 is the reward for doing something exceptionally well, like having a secret cookie recipe or a prime location.
How Supernormal Profit Works in Different Markets
The ability to earn supernormal profit in the long run depends heavily on the type of market a firm operates in. The key factor is the ease with which new firms can enter the market.
| Market Structure | Can it earn Supernormal Profit in the Long Run? | Why? |
|---|---|---|
| Perfect Competition | No | Many sellers, identical products, and easy entry. If one firm makes supernormal profit, new firms enter, increasing supply and driving the price down until only normal profit remains. |
| Monopolistic Competition | No (in theory) | Differentiated products but easy entry. A popular brand can earn supernormal profit in the short run, but imitators will eventually enter and compete it away. |
| Oligopoly | Yes | Few firms, significant barriers to entry (e.g., high start-up costs). Firms can collude or use their market power to maintain supernormal profits. |
| Monopoly | Yes | Single seller, very high barriers to entry (e.g., patents, exclusive resources). The monopolist can restrict output and set high prices to earn supernormal profit indefinitely. |
Real-World Examples of Supernormal Profit
Example 1: A Groundbreaking Invention. A pharmaceutical company develops a new, life-saving drug and gets a patent (20 years of exclusive rights). During this time, they are the only seller. They can charge a price much higher than the cost of production, earning huge supernormal profits. This profit rewards the immense risk and cost of research and development.
Example 2: A Popular Trend. A small coffee shop in a town starts selling a unique "rainbow latte" that goes viral on social media. Long lines form. The shop earns supernormal profit because its product is temporarily unique. However, within months, other coffee shops begin selling their own versions of the rainbow latte. The increased competition slowly eats away at the original shop's supernormal profit.
Example 3: A Natural Monopoly. A local water company has pipes connected to almost every home. It would be incredibly expensive for a second company to build a whole new network of pipes. This natural barrier to entry allows the water company to earn a steady supernormal profit in the long run, which is often regulated by the government.
Important Questions About Supernormal Profit
A: Not always. In the short run, it can be a sign of innovation and a reward for taking risks. It encourages firms to create new products and improve efficiency. However, if it is sustained for a long time by a monopoly that blocks competition and charges very high prices, it can be bad for consumers, leading to less choice and higher costs.
A: Monopoly profit is a specific type of supernormal profit. It is the extra profit earned specifically because a firm has monopoly power (it is the only seller). Supernormal profit is a broader term that can also be earned by firms in an oligopoly or even temporarily by firms in more competitive markets (like the coffee shop example).
A: No. If a firm is making a loss, its total revenue is less than its total costs. Supernormal profit, by definition, is revenue above all costs, including normal profit. A firm must first cover all its costs (reach the normal profit point) before it can earn any supernormal profit.
Conclusion
Footnote
[1] Market Structure: The organizational and other characteristics of a market (like the number of firms, type of product, and ease of entry) that influence the nature of competition and pricing.
[2] Perfectly Competitive: A theoretical market structure with many buyers and sellers, identical products, perfect information, and no barriers to entry or exit.
[3] Economic Profit: Another term for supernormal profit. It is total revenue minus total costs, where total costs include both explicit and implicit (opportunity) costs.
[4] Barriers to Entry: Factors that make it difficult or impossible for new firms to enter a market and compete, such as patents, high start-up costs, or government regulations.
[5] Monopoly Power: The ability of a firm to act as a price maker and charge a price above the competitive level, usually due to being the sole seller in a market.