π Normal Profit vs. Economic Profit: Graphical Representation in Perfect Competition
Understanding profit is crucial in economics. While both normal and economic profit relate to a firm's profitability, they represent different concepts, especially within the context of perfect competition. Let's explore each one, and then compare them!
β¨ What is Normal Profit?
Normal profit is the minimum level of profit required to keep a company operating in a competitive market. It represents the opportunity cost of the owner's resources and time invested in the business.
- π¨βπΌ Opportunity Cost: It's the return the entrepreneur could receive from their next best alternative investment.
- πΌ Zero Economic Profit: Normal profit is achieved when economic profit is zero.
- π° Included in Costs: It's considered a part of the firm's total costs, covering the implicit costs of running the business.
π What is Economic Profit?
Economic profit, on the other hand, is the difference between a firm's total revenue and its total costs, including both explicit (out-of-pocket) and implicit (opportunity) costs. It represents profit above and beyond normal profit.
- β Above Normal Profit: It signifies profit exceeding what's necessary to keep the firm in business.
- π Attracts Competition: Positive economic profit in a perfectly competitive market attracts new firms, increasing supply and eventually driving down prices and profit.
- π Can be Negative: Economic profit can be negative, indicating that the firm is not even covering its opportunity costs.
π Comparison Table: Normal Profit vs. Economic Profit
| Feature |
Normal Profit |
Economic Profit |
| Definition |
Minimum profit to keep a firm operating. |
Total revenue minus total costs (including opportunity costs). |
| Nature |
Part of total costs. |
Profit above normal profit. |
| Economic Profit Relationship |
Achieved when economic profit is zero. |
Can be positive, negative, or zero. |
| Impact on Market Entry |
No impact. |
Positive economic profit attracts new entrants. |
| Formula |
Implicit Costs Covered |
Total Revenue - (Explicit Costs + Implicit Costs) |
| Perfect Competition (Long Run) |
Firms earn only normal profit. |
Firms earn zero economic profit. |
π Key Takeaways
- π― Normal profit is the minimum return required to keep a business running and is included in total costs.
- π Economic profit represents profit above normal profit and influences market dynamics in perfect competition.
- βοΈ In the long run, perfectly competitive firms earn zero economic profit, achieving only normal profit. This can be graphically represented where the firm's average total cost (ATC) curve is tangent to the demand curve (which is also the marginal revenue curve) at the profit-maximizing quantity. At this point, price equals average total cost ($P = ATC$). Because Economic Profit = Total Revenue - Total Cost, and Total Revenue = $P*Q$ and Total Cost = $ATC*Q$, then Economic Profit = $(P*Q) - (ATC*Q)$. Since $P = ATC$, Economic Profit = 0.