Normal and supernormal profits, Managerial Economics

NORMAL AND SUPERNORMAL PROFITS

Normal profit refers to the payment necessary to keep an entrepreneur in a particular line of production.

In economics, it is generally believed that any capital invested in business has an opportunity cost.  The business must offer the investor a prospective return on capital at least equal to the return available on the next best alternative.

The minimum return required to keep an entrepreneur in a particular line of production is what economists call Normal Profits.  Since it represents the opportunity cost of risk capital to the business it is treated as part of the firm's fixed cost which have to be paid if the firm is first to come into existence and then survive in the long run.  Normal profits, therefore are included in the calculations which produce the AC curve.  Therefore, when price exceeds average cost, the firm is said to be earning abnormal /supernormal profits - it is earning a surplus over and above what is necessary to keep it in that business (the surplus is often referred to in economics as Economic rent).

Posted Date: 11/28/2012 5:06:14 AM | Location : United States







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