Normal Profit
Candlefocus EditorIn this market structure, competitive price is determined by the intersection of supply and demand curves. Competitors in the market sell their products at the same price but may incur different production costs. The price at which all producers are able to cover their production costs and earn a zero economic profit is known as the “normal profit” rate. When economic profitability is less than zero, the market price usually falls as producers are forced to reduce their production costs in order to remain in business. When economic profit is greater than zero, the market price usually rises as producers are able to sell some of their products above the normal profit rate.
Normal profit is a key consideration when analyzing industry performance and evaluating business decisions. As mentioned above, normal profit reflects the opportunity costs associated with ensuring the continued operations of an industry or a business. For example, if the cost of capital associated with a business venture or industry is high relative to its normal profit rate, then investing in the venture or industry might not be a great idea. In addition to return on investment, opportunity costs should also be taken into account when evaluating the safety of investing in a business venture.
The concept of normal profit is particularly relevant in the dispute between labor unions and employers when it comes to wage bargaining. According to labor union theory, capitalists will drive wages down to the lowest point needed to keep them in the competition. Even if this means that some businesses make an accounting profit, workers do not benefit from it as the wage rate is driven down to the normal profit rate.
In conclusion, normal profit is an important concept that should not be overlooked when analyzing economic and business situations. It is the rate of return at which economic profit for a company or industry is zero and reflects both implicit and explicit costs associated with operation. As such, normal profit is a valuable metric for evaluating the long-term viability of investing in a particular business venture.