What is normal profit?

To understand what normal profit is, we have to understand the concepts of accounting and economic profit.  Accounting profit is what people generally think of when they think of profit.  This is the difference between what a company takes in in revenue and what it spends in costs.  If I own a small company and we take in $100,000 in revenue in a year and have $50,000 in costs, our accounting profit is $50,000.

However, this does not mean we have made economic profit.  Economic profit takes into account our opportunity costs.  In our example, let us say that I quite a job making $50,000 per year to start my company.  To determine economic profit, we have to include that $50,000 in our costs as something called “implicit costs.”  Now, my costs are equal to my revenues and I have made no economic profit.

When you make no economic profit, it is called “normal profit.” When you make a normal profit, you get enough revenue to cover all your explicit costs (the money you pay out to be able to make your product), but you also get enough revenue to cover the opportunity costs of the options you gave up in order to engage in the business you are in.