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2014 APEE Conference Presentation

What do Economists Mean by Earning a Normal Rate of Return: A Look at What Principles Textbooks Teach.

The pure competitive market structure teaches that free entry and exit of firms is determined by the rate of return earned by firms at the margin. The number of firms reaches as equilibrium when the last firm earns a normal rate of return. Principles of Microeconomics textbooks are somewhat fuzzy over exactly what is a normal rate of return and how is it calculated. Some textbooks calculate a normal rate of return as the return on investor capital as the return to the entrepreneur. However, suppose an entrepreneur rents all of the capital along with all other inputs. The opportunity cost of the rental rate will be counted as a fixed payment toward the cost of production, similar to labor and other inputs. Where is the return to the entrepreneur to induce him to enter the marketplace? Some textbooks do not even include an entrepreneurial return. The goal of our paper is two-fold: 1 – review Principles of Microeconomics textbooks and see what they say about entrepreneurial ability, 2 – attempt to sort out how these textbooks calculate a normal rate of return consistent with their definition of entrepreneurial ability.