Question

What does it mean for a business to earn “normal” profit? What can be said about the company’s accounting profit if it is earning normal profit?

Imagine that you had a business like Kismet. How much accounting profit would you need to make in order to make "normal profit" (also called "zero economic profit")? This number is personal to you...everyone's answer will be different. Explain why you would require that much accounting profit (and why less accounting profit is not enough).

Answer 1

Solution: A firm is said to be earning normal profit if the difference between the total cost and total revenue is equal to 0. But here Total cost implies implicit cost and explicit cost both.

But for an accounting profit we need Total revenue should be greater than Total accounting cost. This accounting cost involves only Explicit cost.

So Economic profit = TOtal revenue - ( Explicit cost + Implicit cost)

WHile Accounting profit = Total Revenue - (Explicit cost)

Implicit cost are also known as opportunity cost or hidden cost. For example you are running a business in your own building so you don't need to pay the rent.So this rent is your implicit cost.Try to think in this way if you have given that building on rent then you could have earned rent out of that so you will not earn this rent now because you are using the building for your business purpose.This rent is forgone by you.So this is the opportunity cost.

Let us suppose that accounting profit is 50000.

And the economic profit = TOtal revenue - (Explic cost + Implicit cost)

Let us suppose that implicit cost = 50000, let total revenue = 100000

So economic profit = 100000 - Explicit cost - Implicit cost

Economic profit = 100000- Explicit cost - Implicit cost

Economic profit = Accounting profit -Implicit cost

If Accounting profit = Implicit profit we will have normal profit .

So Economic profit = 50000- 50000 = 0 .

Only if Accounting profit is equal to implicit cost we will get normal profit. If Accounting profit < Implicit cost we will suffer from economic losses.