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May 28, 2024 

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LOSS MINIMIZATION RULE: A rule stating that firm minimizes economic loss by producing output in the short run that equates marginal revenue and marginal cost if price is less than average total cost but greater than average variable cost. In the short run, a firm incurs total fixed cost whether or not it produces any output. As such, if the market price is falls below average total cost, it must decide if the economic loss from producing the quantity of output that equates marginal revenue and marginal cost is more or less than the economic loss incurred with shutting down production in the short run (which is equal to total fixed cost).

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NORMAL PROFIT:

The opportunity cost of using entrepreneurial abilities in the production of a good, or the profit that could be received by entrepreneurship in another business venture. Like the opportunity costs of other resources, normal profit is deducted from revenue to determine economic profit. It is, however, never included as an accounting cost when accounting profit is computed.
Normal profit is the opportunity cost of using entrepreneurship in production. The notion that entrepreneurship incurs an opportunity cost in production is often overlooked in the business world because it does not involve an explicit payment, that is, accounting cost. For most business firms, normal profit is invariably combined with economic profit and simply designated as accounting profit.

For example, a worker like Phoebe Pankovic might be paid $10 an hour to produce Wacky Willy Stuffed Amigos (those cute and cuddly armadillos and tarantulas) to compensate her for a $10 wage that could be earned producing another good, such as Hot Momma Fudge Bananarama Ice Cream Sundaes.

In a similar manner, the entrepreneur who organizes the production of Wacky Willy Stuffed Amigos, William J. Wackowski, foregoes profit that could be earned organizing the production of another good, such as Hot Momma Fudge Bananarama Ice Cream Sundaes. This foregone profit is an opportunity cost of the entrepreneurship, it is normal profit, and is deducted from revenue to calculate economic profit. However, it is NOT deducted from revenue to calculate accounting profit.

Normal profit plays a key role in the long-run production decision of a firm, that is, whether or not to remain in business. As a general rule, a firm compares accounting profit generated from one production, with what could be generated from another production. If accounting profit is greater in the alternative activity, then the firm is inclined to shut down current production, and begin the alternative.

If, for example, William J. Wackowski can generate more profit selling hot fudge sundaes than stuffed animals, then he is likely to shut down The Wacky Willy Company and start up a Hot Momma Fudge Bananarama Ice Cream Shoppe.

This decision is conceptually captured by normal profit. Normal profit is what William J. Wackowski would be earning with hot fudge sundae production. By deducting this alternative profit from his reported accounting profit, the result is economic profit. If economic profit is greater than zero, then William is doing better, and earning more, making stuffed animals. If economic profit is less than zero (even though accounting profit is positive), then William could do better, and earn more, by switching his entrepreneurship to hot fudge sundae production.

<= NORMAL GOODNORMATIVE ECONOMICS =>


Recommended Citation:

NORMAL PROFIT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: May 28, 2024].


Check Out These Related Terms...

     | accounting profit | accounting cost | economic profit | profit |


Or For A Little Background...

     | entrepreneurship | opportunity cost | implicit cost | explicit cost | economic cost | cost | production | production cost | business | factors of production | microeconomics | short-run production analysis |


And For Further Study...

     | total cost | variable cost | fixed cost | average cost | marginal cost | legal business organizations | firm objectives | opportunity cost, production possibilities | profit maximization |


Related Websites (Will Open in New Window)...

     | American Accounting Association |


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