Normal Profit
Categories: Accounting
Time to take off your accounting thinking cap and put on your economic thinking cap. You ready?
Normal profit is when economic profit is zero, where total revenue equals total cost. At first blush, this sounds unintuitive...how can a “normal” profit be zero? Isn’t that...no profit?
In accounting, yes, but in economics, no. Normal profit, or an economic profit of zero, is considered great. But why?
Accountants only take into account explicit costs...things with price tags on them: how much that building cost, the inputs to make the things, the labor...explicit costs. Economists take explicit costs into account, plus implicit costs, which are the opportunity costs of that money.
Opportunity cost has to do with what other things you could have done with that money. Maybe you could have sold the land instead of building a GoT-themed escape room biz on it. To decide if you should run your escape room business or just sell the land, you’ll have to compare the net revenue you’d get from each option. Now you’re thinking like an economist.
When you realize a normal profit, or economic profit of zero, that means you’re using your resources as efficiently as possible. After comparing your options, you decide the business is the better option, because total revenue equals the implicit cost of how much you would’ve earned had you sold the land, plus the explicit costs of running the business.
For instance, your explicit costs of running the business might be $100k, and your implicit costs...the revenue you’re losing from not just selling the land...is $50k. That makes total economic costs $150k, which equals your revenue from the business. Then it’s smarter...more efficient...to stay in business than to sell.