Normal profit

  • Normal profit is a situation where a firm makes sufficient revenue to cover its total costs and remain competitive in an industry.
  • In measuring normal profit, we include the opportunity cost of working elsewhere.
  • When a firm makes normal profit we say the economic profit is zero.

Normal profit = total revenue – total costs

  • Where total costs =
    • Explicit costs (rent, labour costs, raw materials +
    • Implicit costs (opportunity cost of capital/working elsewhere)

Diagram showing normal profit

break-even-shut-down-normal-profit

Normal profit occurs at an output where average revenue (AR) = average total costs (ATC)

Does normal profit = zero profit?

Normal profit implies zero economic profit. However, this can include ‘accounting profit’. This is because included in the total costs is a minimum level of recompense for the owners of the company. For example, if a typical salary was £20,000 working elsewhere, this salary of £20,000 would be included in total costs.

A firm can have accounting profits of £20,000 – but as this is an implicit cost of owning a business it is included in total costs.

Normal profit in perfect competition

Perfect competition in the long-run

perfect-competition

In perfect competition, there is freedom of entry and exit. If the industry was making supernormal profit, then new firms would enter the market until normal profits were made.

This is why normal profits will be made in the long run. At Q1 – AR=ATC.

Economic – Supernormal profit

Economic profit is any profit above the level of normal profit. It is also referred to as supernormal profit.

In monopoly, firms are able to make greater than normal profits. There are barriers to entry and they can charge a price higher than average costs.

Supernormal profit in monopoly

Most markets have a degree of barriers to entry and exit. There are sunk costs which deter entry. Therefore, even if firms are making supernormal profit, new firms may not be able to enter and compete.

monopoly-diagram-2017The market power enables firms to set a price (Pm greater than average cost.)

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