Markup is the ratio between the cost of a good or service and its selling price. It is expressed as a percentage over the cost. A markup is added onto the total cost incurred by the producer of a good or service in order to cover the costs of doing business and create a profit. The total cost reflects the total amount of both fixed and variable expenses to produce and distribute a product. Markup can be expressed as a fixed amount or as a percentage of the total cost or selling price. Retail markup is commonly calculated as the difference between wholesale price and retail price, as a percentage of wholesale. Other methods are also used.
Price determination
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Profit
- Assume: Sale price is 2500, Product cost is 2000
- Profit = Sale price âˆ' Cost
- 500 = 2500 âˆ' 2000
Markup
Below shows markup as a percentage of the cost added to the cost to create a new total (i.e. cost plus).
- Cost × (1 + Markup) = Sale price
- or solved for Markup = (Sale price / Cost) âˆ' 1
- or solved for Markup = (Sale price âˆ' Cost) / Cost
- Assume the sale price is $1.99 and the cost is $1.40
- Markup = ($1.99 / 1.40) âˆ' 1 = 42%
- or Markup = ($1.99 âˆ' $1.40) / $1.40 = 42%
- To convert from markup to profit margin:
- Sale price âˆ' Cost = Sale price × Profit margin
- therefore Profit Margin = (Sale price âˆ' Cost) / Sale price
- Margin = 1 âˆ' (1 / (Markup + 1))
- or Margin = Markup/(Markup + 1)
- Margin = 1 âˆ' (1 / (1 + 0.42)) = 29.5%
- or Margin = ($1.99 âˆ' $1.40) / $1.99 = 29.6%
Another method of calculating markup is based on percentage of cost. This method eliminates the two-step process above and incorporates the ability of discount pricing.
- For instance cost of an item is 75.00 with 25% markup discount.
- 75.00/(1 âˆ' .25) = 75.00/.75 = 100.00
Comparing the two methods for discounting:
- 75.00 × (1 + .25) = 93.75 sale price with a 25% discount
- 93.75 × (1 âˆ' .25) = 93.75 × .75 = 70.31(25)
- cost was 75.00 and if sold for 70.31 both the markup and the discount is 25%
- 75.00 /(1 âˆ' .25) = 100.00 sale price with a 25% discount
- 100.00 × (1 âˆ' .25) = 100.00 × .75 = 75.00
- cost was 75.00 and if sold for 75.00 both the profit margin and the discount is 25%
These examples show the difference between adding a percentage of a number to a number and asking of what number is this number X% of. If the markup has to include more than just profit, such as overhead, it can be included as such:
- cost × 1.25 = sale price
or
- cost / .75 = sale price
Aggregate supply framework
P = (1+μ) W. Where μ is the markup over costs. This is the pricing equation.
W = F(u,z) Pe . This is the wage setting relation. u is unemployment which negatively affects wages and z the catch all variable positively affects wages.
- Sub the wage setting into the price setting to get the aggregate supply curve.
P = Pe(1+μ) F(u,z). This is the aggregate supply curve. Where the price is determined by expected price, unemployment and z the catch all variable.
See also
- Administered prices
- Cost-plus pricing
- Marketing
- Markup rule
- Pricing
References
