The concepts of normal and supernormal profit enable economists to get round a significant theoretical problem. Figure 5.1 below shows a perfectly competitive firm in long-run equilibrium.
The firm’s total sales revenue and also total cost of production are shown by the rectangle bounded by the points OP1XQ1. Because total cost = total revenue, the firm apparently makes no profit.
But why should a firm stay in the market if in the long run profit is zero?
The answer lies in the difference between normal and supernormal profit.
Normal profit is the minimum profit necessary to keep incumbent firms in the market. However, the normal profit made by firms already in the market is insufficient to attract new firms into the market. Because a firm must make normal profit to stay in production, economists treat normal profit as a cost of production, which is included in a firm’s average cost curve. In the long run, firms that cannot make normal profit have to leave the market.
Supernormal profit (which is also called above-normal profit and abnormal profit) is any extra profit over and above normal profit. In the long run, and in the absence of entry barriers, supernormal profit performs the important economic function of attracting new firms into the market.
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