Accounting Profit vs Normal Profit
Accounting Profit and Normal Profit are two Production & Costs concepts in AP Economics that students often mix up. Accounting profit is total revenue minus explicit costs, as recorded on a firm's financial statements. Normal profit is the minimum return needed to keep a firm in business, equal to the opportunity cost of the owner's resources. Here is how they compare side by side.
Explicit costs are direct, out-of-pocket payments like wages, rent, and materials. Accounting profit does not include opportunity costs, so it is typically higher than economic profit. It is used for tax and reporting purposes.
It is the implicit cost of entrepreneurship and is included in economic profit calculations. When economic profit is zero, the firm is earning normal profit, meaning it is covering all costs, including opportunity costs.
Accounting Profit vs Normal Profit: A Number on the Books and a Number in the Owner's Head
| Accounting Profit | Normal Profit | |
|---|---|---|
| Definition | Total revenue minus explicit costs | The return just large enough to keep the owner's resources in this business |
| Where the figure comes from | The firm's own financial statements | The value of the owner's next best alternative use of time and money |
| Which costs it involves | Only out-of-pocket payments made to outsiders | It is itself an implicit cost, an opportunity cost of staying |
| Profit or cost | A profit, and the bottom line of an income statement | An economist counts it as a cost of doing business |
| Who could compute it | An auditor with the receipts | Nobody but the owner, since it depends on options only she can rank |
| Value in long-run competitive equilibrium | Positive, since explicit costs are covered with room left over | Exactly what the firm ends up earning, no more and no less |
| What it tells you about staying open | Very little on its own | Everything, since earning less than it means the owner should leave |
The same firm can post a healthy accounting profit and be exactly breaking even
Take an owner running a print shop, with illustrative figures for one year. Revenue is 200,000 dollars. Rent is 40,000, wages are 70,000 and materials are 30,000. Those three payments are explicit costs and add to 140,000 dollars, so accounting profit is 200,000 minus 140,000, which is 60,000 dollars. That is the figure the tax return reports and the number most people mean by profit. Now count what the owner gave up. She left a job paying 50,000 dollars a year to run the shop, and she put 100,000 dollars of her own savings into it instead of lending the money out at an illustrative 5 percent, forgoing 5,000 dollars of interest. Those implicit costs come to 55,000 dollars, and that 55,000 is her normal profit: the least the shop must return before staying beats her alternatives. Economic profit is 60,000 minus 55,000, which is 5,000 dollars, so she is ahead but not by much. Change one number and the point lands. Had the forgone salary been 55,000 instead of 50,000, normal profit would be 60,000 and economic profit would be zero, with the books still showing a 60,000 dollar profit. Both formulas are worked through at /calculate/accounting-profit and /calculate/economic-profit.
Normal profit is a cost, which is why earning zero economic profit is not failure
Once you accept that normal profit belongs on the cost side, several results stop sounding strange. A firm earning zero economic profit is covering every explicit payment and also matching whatever the owner could have earned elsewhere. Nobody is being underpaid and nothing is going wrong. That is the state a competitive industry is pushed toward in the long run, because positive economic profit attracts entrants whose extra supply pushes the price down, and negative economic profit drives firms out until the price recovers. The process stops when economic profit is zero, which is another way of saying every surviving firm earns exactly normal profit. This also explains why accounting profit alone cannot tell you whether an industry is worth entering. A shop that clears 60,000 dollars on the books is thriving if the owner's next best option pays 20,000 and quietly failing if it pays 90,000. The books never contain that comparison, since no cheque is ever written for a forgone salary. Economists put implicit costs into total cost precisely so the profit figure that comes out the other end answers the question a decision maker actually has. See /micro/perfect-competition for how entry and exit drive the adjustment.
Frequently asked questions
Is normal profit a cost or a profit?
Economists treat normal profit as a cost, specifically an implicit cost equal to the opportunity cost of the owner's own time and capital. It is included in economic cost, which is why a firm earning only normal profit shows zero economic profit even though its accounts show a positive figure.
Can a firm earn accounting profit but no economic profit?
Yes, and it is the standard outcome in a competitive industry over the long run. Accounting profit subtracts only explicit costs, so a firm whose accounting profit happens to equal the owner's forgone earnings has an economic profit of exactly zero.
What is the difference between normal profit and economic profit?
Normal profit is the minimum return needed to keep the owner's resources in the business, while economic profit is whatever is left after every cost, explicit and implicit, has been subtracted. Economic profit is therefore the surplus above normal profit rather than a separate calculation.
Live Perfect Competition graph. Drag the curves, or open the full version.
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