Economic Profit vs Normal Profit
Economic Profit and Normal Profit are two Production & Costs concepts in AP Economics that students often mix up. Economic profit is total revenue minus both explicit and implicit costs, including opportunity costs. 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.
Implicit costs represent the value of resources the firm owns, such as the owner's time or capital. Economic profit accounts for all costs of production, making it a better measure of true profitability. A firm earns zero economic profit when it covers all opportunity costs.
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.
Economic vs Normal Profit: One Is a Result, the Other Is a Cost
| Economic Profit | Normal Profit | |
|---|---|---|
| Can it be negative | Yes, and a negative value is an economic loss that drives exit in the long run | No, since a best forgone alternative cannot be worth less than nothing |
| Where it sits in the cost curves | Outside them, measured as the gap between price and average total cost | Inside them, already counted within average total cost |
| Value in long-run competitive equilibrium | Zero | Fully earned, which is exactly why the firm stays |
| Sign that triggers entry or exit | Positive draws entry, negative drives exit | No sign to read, since it is a benchmark rather than an outcome |
| Relation to accounting profit | Accounting profit minus implicit costs | The implicit-cost slice contained inside accounting profit |
| What changes it while the books stay identical | A better outside option for the owner lowers it | A better outside option for the owner raises it |
The same bakery can post a $90 thousand profit and still run an economic loss
A bakery takes in $340 thousand a year and pays $250 thousand in explicit costs for flour, wages, and rent. Accounting profit is $90 thousand, and that is the figure on the tax return. Now count what the owner gave up: a salary of $70 thousand at her old job, plus $200 thousand of her own money tied up in ovens that would have earned 6 percent, or $12 thousand, elsewhere. Implicit costs total $82 thousand, and that is her normal profit. Economic profit is $90 thousand minus $82 thousand, or $8 thousand. She is beating her next best alternative, so she stays and the industry attracts entrants. Now change one number outside the business. Suppose the job she left now pays $80 thousand. Implicit costs rise to $92 thousand and economic profit becomes negative $2 thousand. Nothing inside the bakery moved. Its accounting profit is still $90 thousand, its ovens still work, and it is now running an economic loss purely because her alternative improved.
Zero economic profit is a resting point, not a failure
The sentence that costs students marks is that the firm earns zero economic profit, so it shuts down. Zero economic profit means the owner is earning exactly her opportunity cost, the normal profit, and is doing precisely as well here as in her best alternative. She has no reason to leave and outsiders have no reason to enter. That is long-run equilibrium in perfect competition, drawn as price equal to the minimum of average total cost. Shutdown is a separate short-run decision, made by comparing price with average variable cost, and a firm can earn zero economic profit while sitting comfortably above its shutdown price. Keep three levels straight when you write: positive economic profit invites entry, zero economic profit is the resting point, and losses drive exit only in the long run, because in the short run a firm with price above average variable cost keeps operating to cover part of its fixed costs.
On a firm diagram, economic profit is a rectangle and normal profit is invisible
To find economic profit on a firm diagram, read price at the profit-maximizing quantity, read average total cost at that same quantity, and multiply the vertical gap by the quantity. The shaded rectangle is economic profit. Normal profit has no rectangle, because it was already subtracted when the average total cost curve was drawn: that curve includes the owner's forgone salary and the forgone return on her capital alongside flour and wages. When price sits exactly on the average total cost curve, the rectangle has zero height, and the firm is earning normal profit and nothing beyond it. Two habits follow from this. Measure the gap at the quantity where marginal revenue equals marginal cost, not at the lowest point of average total cost, since those are different quantities for a monopolist. And never shade a separate area for normal profit, because the diagram contains no such region and a grader reads that shading as a misunderstanding of what average total cost already includes.
Frequently asked questions
Does a firm earning zero economic profit stay in business?
A firm earning zero economic profit stays in business, because zero economic profit means every cost is covered, including the owner's opportunity cost. The owner is doing exactly as well as in her next best alternative, so leaving gains her nothing. Zero economic profit is the long-run resting point in perfect competition, where price equals the minimum of average total cost and neither entry nor exit is attractive. Confusing it with zero accounting profit, which would mean revenue barely covers out-of-pocket costs, is the usual source of the error.
How is normal profit related to accounting profit?
Normal profit is the implicit-cost slice of accounting profit. Accounting profit subtracts only explicit costs from revenue, so it still contains the owner's forgone salary and the forgone return on her own capital. Subtract those implicit costs and what remains is economic profit. In the bakery above, accounting profit of $90 thousand splits into normal profit of $82 thousand and economic profit of $8 thousand. A firm reporting a healthy accounting profit can therefore be earning nothing above normal profit once the owner's alternatives are priced in.
Why does normal profit count as a cost rather than a profit?
Normal profit counts as a cost because the resources an owner supplies have alternative uses, and economics prices every input at what it could earn elsewhere. Her time could earn a salary and her capital could earn a return. If the business cannot cover those amounts, those resources should move, exactly as they should if the business could not pay its flour supplier. Building normal profit into the average total cost curve is what makes the zero-economic-profit condition meaningful, since a firm at that point is paying every supplier, its owner included.
Live Perfect Competition graph. Drag the curves, or open the full version.
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