Normal Profit

Published Jan 14, 2023

Definition of Normal Profit

Normal profit is the minimum amount of profit that a business must make in order to stay in business, considering both explicit and implicit costs. That means it is the minimum overall return that a business needs to cover its costs and stay afloat (i.e., keep its factors of production in use). It is also known as zero economic profit.

Note that normal profit is different from accounting profit because the latter only takes explicit costs into account. That means, to reach zero economic profit, firms usually need to record a positive accounting profit.

Example

To illustrate this, let’s look at a small bakery. The bakery has to cover its costs, such as rent, utilities, and wages, in order to stay in business. In addition to that, the owners also need to make a profit to make the business worthwhile. That means they need to make at least as much profit as they could make by pursuing their next best alternative to cover their opportunity costs. This is the normal profit.

Why Normal Profit Matters

Normal profit is an important concept for businesses because it is the minimum amount of profit they must make to justify staying in business long-term. If they are not making at least zero economic profit, they would be better off pursuing other business ventures.

In addition to that, it is also an important concept in macroeconomics because, in perfect competition, all firms make exactly zero economic profit. Thus, it can be used to determine the health and strength of an industry.