Economic vs. Normal Profit: What's the Difference?
Edited by Janet White || By Harlon Moss || Updated on October 26, 2023
Economic profit accounts for both explicit and implicit costs, while normal profit is the minimum profit required to keep an owner-operated business running.
Key Differences
Economic profit is a comprehensive metric that captures the total profitability of a business after accounting for both explicit costs (like rent or salaries) and implicit costs (like the opportunity cost of capital). On the other hand, normal profit represents the level of profit that a business owner expects to earn, considering the risks associated with the business and ensuring the entrepreneur doesn't suffer a financial loss.
When discussing economic profit, it's imperative to understand the role of opportunity costs, or the potential returns given up when one option is chosen over another. In contrast, normal profit doesn't delve into opportunity costs but is simply the baseline profit that makes operating the business worthwhile.
Businesses aim to achieve economic profits, which indicates they are earning over and above the normal profit. This means that not only are they covering their explicit costs, but they're also exceeding the implicit costs. Conversely, if a business is only earning a normal profit, it suggests they're just breaking even after considering all their opportunity costs.
It's important to note that achieving only a normal profit isn't indicative of a business failure. Earning a normal profit means the business is sustaining itself and ensuring the owner's time and resources are appropriately compensated. Yet, in terms of economic profit, if it's zero, it implies the firm is only earning a normal profit.
In many economic models, firms in perfectly competitive markets will only earn a normal profit in the long run. When economic profits exist, they attract new entrants, increasing competition and driving profits back down. However, the idea of normal profit remains essential as it provides the benchmark against which economic profit is measured.
ADVERTISEMENT
Comparison Chart
Definition
Profit after deducting both explicit and implicit costs.
Minimum profit required to sustain a business operation.
Incorporates
Both explicit (actual) and implicit (opportunity) costs.
Only the expected return on investment.
Indication
Business's success over and above the normal rate of return.
Business is breaking even after considering opportunity costs.
Long-term Competitive Market
Tends to be zero in perfectly competitive markets.
Remains constant as it's the expected return.
Desirability
Businesses aim to achieve economic profit.
Businesses aim to achieve at least a normal profit.
ADVERTISEMENT
Economic and Normal Profit Definitions
Economic
Concerning the principles of a particular system of money.
They had a long debate on economic theories.
Normal Profit
The expected return that compensates for the risk of a business.
Despite the challenges, the venture maintained its normal profit.
Economic
Related to the production, distribution, and consumption of goods and services.
The economic growth of the country has been consistent.
Normal Profit
The minimum profit needed to keep a business operational.
She was content that her startup was earning a normal profit in its first year.
Economic
Referring to the wealth or financial state of a country or person.
His economic status improved after getting a new job.
Normal Profit
The break-even level after accounting for opportunity costs.
After analyzing the finances, the company was just above the normal profit mark.
Economic
Efficient in terms of time, money, or effort.
Solar panels provide an economic alternative to traditional energy sources.
Normal Profit
The essential earning ensuring an entrepreneur's resources are compensated.
The goal for the first quarter was to at least reach a normal profit.
Economic
Involving considerations of financial gain.
The city made an economic decision to boost tourism.
Normal Profit
A benchmark in competitive markets indicating zero economic profit.
In saturated markets, most businesses only achieve a normal profit.
Economic
Of or relating to the production, development, and management of material wealth, as of a country, household, or business enterprise.
FAQs
Why is opportunity cost important in calculating economic profit?
Opportunity cost represents the value of the next best alternative foregone, crucial for understanding the true profitability of a choice.
What is economic profit?
Economic profit is the difference between total revenue and total costs, including both explicit and opportunity costs.
Why is normal profit important?
It represents the threshold for a business to remain viable in the long term.
Can a firm have high accounting profit but low or negative economic profit?
Yes, if the opportunity costs are high, this scenario is possible.
How is economic profit different from accounting profit?
Accounting profit only considers explicit costs, while economic profit includes both explicit and opportunity costs.
Why might a firm continue operating at normal profit?
It may serve strategic purposes, maintain market presence, or await better market conditions.
How does innovation impact economic profit?
Innovation can lead to increased demand, higher revenue, and thus higher economic profit.
Is it possible to have zero economic profit and still be successful?
Yes, as zero economic profit means earning just enough to cover all costs, including opportunity costs.
How do changes in the market affect economic and normal profit?
Market changes can alter costs, revenue, and opportunity costs, affecting both types of profit.
How do companies maximize economic profit?
By increasing revenue, reducing costs, and wisely choosing opportunities with the highest returns.
Can economic theories on profit apply to all types of businesses?
While principles are broadly applicable, their impact can vary based on industry, scale, and market conditions.
Can economic profit be negative?
Yes, if total costs (including opportunity costs) exceed total revenue.
How does economic profit affect business decisions?
It helps businesses assess the true value of their choices and allocate resources efficiently.
How is normal profit calculated?
It’s generally embedded in total costs as the fair return expected on invested capital.
Can a business survive with only normal profit?
Yes, but it won’t have excess returns above the opportunity cost of capital.
How does normal profit relate to perfect competition?
In perfect competition, firms typically earn normal profit in the long run due to free market entry and exit.
Is normal profit a sign of poor performance?
Not necessarily; it may indicate stability in competitive markets.
Is normal profit included in economic profit?
Yes, it's part of the opportunity costs considered in economic profit calculation.
What is normal profit?
Normal profit is the minimum profit necessary to keep a firm in operation; it’s considered an opportunity cost.
Can a firm have positive economic profit indefinitely?
It's rare in competitive markets, as positive economic profit often attracts competitors, driving profits down.
About Author
Written by
Harlon MossHarlon is a seasoned quality moderator and accomplished content writer for Difference Wiki. An alumnus of the prestigious University of California, he earned his degree in Computer Science. Leveraging his academic background, Harlon brings a meticulous and informed perspective to his work, ensuring content accuracy and excellence.
Edited by
Janet WhiteJanet White has been an esteemed writer and blogger for Difference Wiki. Holding a Master's degree in Science and Medical Journalism from the prestigious Boston University, she has consistently demonstrated her expertise and passion for her field. When she's not immersed in her work, Janet relishes her time exercising, delving into a good book, and cherishing moments with friends and family.
