Where do higher prices come from? Role of profits and markups

Published: 27/12/2023
Gorana Lukinić Čardić and ​​​​​​​Jurica Zrnc

Gorana Lukinić Čardić, Senior Advisor, Economic Analysis Department
Jurica Zrnc, Advisor, Monetary Policy Department

Strong acceleration of inflation in 2022 prompted the question of the extent to which corporate profits and markups contribute to inflationary pressures. The contribution of unit profits to GDP deflator growth in 2022 was bigger than that over a longer period of time before and exceeded the contribution of unit labour costs and unit taxes. However, profit margins of non-financial corporations in Croatia, after having fallen in 2020 by 2022 returned close to the 2019 level. Econometric estimates of markups point to the same conclusion. Keeping markups at a relatively stable level seemingly eliminates corporate profits as one of the potential determinants of inflation. In the conditions of a pronounced rise in the costs of intermediate goods, which is much faster than economic activity and wage growth, stable markups are actually in line with a noticeable increase in corporate profits and a large contribution of unit profits to GDP deflator growth. And amid removal of the remaining bottlenecks in production chains and falling prices of raw materials, corporate profits may serve as a buffer for the inflationary effects of a surge in labour costs.

Strong acceleration of inflation on a global level in 2022 prompted a discussion on the relationship between corporate markups and developments in inflation. Regardless of the ultimate cause, to the extent that it is not “imported”, inflation is necessarily reflected in the growth of nominal wages, profits or taxes. This raises the question of the extent to which corporate profits or markups contribute to domestic inflationary pressures, particularly if we bear in mind that inflation has reached very high levels and has proven to be much more persistent than initially expected. In this blog, we examine the developments in price and profit margins of non-financial[1] corporations in Croatia and attempt to delve deeper into their relationship.

The GDP deflator is one of the indicators used to monitor price developments, even though it differs conceptually from the (harmonised) index of consumer prices. In contrast with the consumer price index that monitors the prices of goods and services consumed by the households, the GDP deflator includes the prices of all final products and services produced by the domestic economy, regardless of whether they are intended for domestic consumption (final or investment) or exports. Also, while import prices are included in the consumer price index, the calculation of the GDP deflator excludes the imports deflator so GDP deflator is one of the common indicators of domestic price pressures. The increase in the GDP deflator of 9.5% in 2022 shows that inflationary pressures that year were only partially of an imported nature and the harmonised consumer price index rose by 10.7%, somewhat faster than the GDP deflator.

The decomposition of the change in the GDP deflator[2] shows that its growth in 2022 was mostly driven by unit profits, whose contribution was much bigger than the long-term average and largely exceeded the contribution of unit labour costs (Figure 3.1). Such developments reflect a growth of unit profits faster than that of unit labour costs, which resulted in a higher share of profits (approximated, for the sake of simplicity, by gross operating surplus and mixed income) in GDP (Figure 3.2). After a strong acceleration in 2022, the growth in unit profits peaked at the beginning of 2023 and in the second and third quarter of 2023, the contribution of unit profits to GDP deflator growth decreased. By contrast, the contribution of unit labour costs, which accelerated especially in the second half of 2022, remained at an elevated level.


The increase in unit profits does not necessarily mean that corporates increased markups and profit margins. The markup is defined as the price to marginal cost ratio, while profit margins are the profits[3] to sales ratio. Markups are often used as an indicator of corporate market power because they show the extent to which a firm may charge a price above the marginal cost of its product. Profit margins are an indicator of corporate profitability, i.e. profits per unit of sales. Markups and profit margins may differ, with the treatment of fixed costs being one of the key differences between them. For instance, a firm with high fixed costs must have high markups to generate any profit at all. Similarly, the share of profits in value added that is measured in national accounts[4] differs conceptually from markup indicators and this may result in a divergence between markup indicators and the profit share in GDP. Thus, when the costs of intermediate goods grow faster than labour costs, as was the case recently, the share of profits in GDP may rise even if markups are stagnant or falling (Hahn, 2023). Therefore, to arrive at a conclusion on the impact of corporate pricing policy on inflation, it is also necessary to assess the developments in corporate markups and profit margins.

Econometric estimates of markups based on reports of corporates in Croatia do not suggest their significant increase in 2022 relative to 2019, and the same is true of developments in profit margins. Markups need to be econometrically estimated because data on prices and marginal costs of corporates are not available. To do so we used the standard econometric model designed for markup estimation (De Loecker and Warzynski, 2012[5], De Loecker et al., 2021[6]). Twelve different versions of the model were estimated, all pointing to a similar conclusion: markups rose after a sharp fall in the pandemic 2020[7], but only to reach their 2019 level. The estimates of percentage change in markups from 2019 based on different models thus range from an increase in markups of 2% to a decrease of 2.5% and the median model (–0.6%) and the average of all models (–0.5%) shows a small fall in markups (Figure 3.3). Profit margins moved in parallel with markups (Figure 3.3).

Even with relatively stable markups, firms increased their nominal value of profits significantly, as seen in the growth of the contribution of unit profits to the GDP deflator. In 2022, total corporate profits[8] rose steeply from 2019 (net profits 63%, EBITDA 42% and operating profits 34%[9]), greatly outpacing labour costs (22%), which is in line with the seemingly contradictory indicators pointing to the increase in the share of profits in the national accounts statistics and constant corporate markups. Colonna at al., 2023[10] and Hahn, 2023 have demonstrated using different indicators of corporate profits that similar developments were present in some euro area countries, i.e. that the nominal value of profits rose sharply even with relatively stable markups. Amid strong cost pressures, stable profit margins and markups indicate that corporates raised their product prices at an intensity similar to their cost growth, which greatly outpaced GDP growth. This led to a surge in the nominal amount of profits and their share in GDP.

It appears that corporates have not fully transferred the increase in input prices to buyers, but have left part of the increase to be shouldered by employees whose wages grew slower than the costs of intermediate goods and sales, thus helping corporates to preserve their markups. As shown previously, the average markups and profit margins of corporates have been relatively stable over the past years. However, the shares of the costs of different production factors in sales have changed considerably (Figure 3.4). Thus, after 2020, the costs of intermediate goods to sales ratio rose steeply, suggesting that corporates raised their product prices at a pace that was slower than the growth of their input costs. At the same time, employee costs rose even slower than the costs of intermediate inputs and sales, with the ratio of employee costs to sales falling. This points to the conclusion that corporates maintained relatively stable markups by distributing the burden of higher costs of intermediate goods between employees and buyers[11].

The observed corporate behaviour is in line with the simple pricing policy of stable markups, but further research is needed to establish the determinants of prices, markups and profits. On the one hand, corporates were faced with a sharp increase in input prices, which increase costs and diminish profitability. On the other hand, supply bottlenecks, product shortages and robust domestic and foreign demand have made it easier for firms to raise the prices of their products and make up for the higher input costs. Amid such a widespread increase in costs and prices, it was difficult for consumers to assess whether individual price increases were justified and they probably had fewer opportunities and little propensity to switch to other producers or traders. Wage rigidity also helped corporates to alleviate cost increases and maintain markups. Aggregate demand remained robust as households decreased their savings rate and foreign demand for services also made a big contribution. To estimate the exact contribution of each of these elements, one would need to estimate demand elasticity, measure the firm production structure and the effects of uncertainty, which all require much more detailed data than those available currently. An important factor is also the relative strength of numerous shocks that hit the economy in the past years and their effect on inflation, which is a topic of a growing number of research studies throughout the world.

As the remaining bottlenecks in production chains are eliminated and prices of raw materials are falling, we can expect a further decline in the contribution of unit profits to GDP deflator growth. Profits could serve as a “buffer” against price pressures generated by employees seeking to offset the fallen purchasing power of wages due to the general price increase. However, any corporate effort to avoid a considerable fall in profits might lead to an increase in markups, which is one of the risks for inflation outpacing current expectations.


  1. Only non-financial corporations (hereinafter: corporates, firms) are analysed in the blog while financial institutions are excluded.

  2. The components of income approach to nominal GDP are used, with both the nominal GDP and its three components being divided by real GDP to arrive at, on the one hand, the GDP deflator, and on the other (1) unit labour costs (more precisely, nominal compensation of employees to real GDP ratio), (2) unit profits (more precisely, the gross operating surplus and gross mixed income to real GDP ratio) and (3) unit taxes (more precisely, taxes net of subsidies to real GDP ratio).

  3. Three standard definitions of profits are used in this blog: net profits after tax, EBITDA and operating profits. EBITDA is defined as operating income minus operating expenses plus depreciation and operating profits equal income from sale minus employee costs and material costs. It should be borne in mind that annual financial statements of corporates are available with a much bigger time lag than the national accounts.

  4. According to data available in the national accounts, profits are approximated by a category of gross operating surplus and mixed income, which also comprises some elements that would not be considered profits in a narrow sense (Haskel, 2023, Hahn, 2023). Hahn, E. (2023): How have unit profits contributed to the recent strengthening of euro area domestic price pressures?, May 2023, link: https://www.ecb.europa.eu/pub/economic-bulletin/focus/2023/html/ecb.ebbox202304_03~705befadac.en.html; Haskel, J. (2023): What's driving inflation: wages, profits, or energy prices?, Speech given at the Peterson Institute for International Economics, Washington DC, 25 May 2023.

  5. De Loecker, J. and Warzynski, F. (2012): Markups and firm-level export status, American economic review, 102(6), 2437 – 2471

  6. De Loecker, J., Eeckhout, J. and Unger, G. (2020): The rise of market power and the macroeconomic implications, The Quarterly Journal of Economics, 135(2), 561 – 644.

  7. Note should be taken that markup estimates in 2020 and 2021 were probably influenced by government support to the economy, which made it possible for corporates to have much higher labour costs than they would have had should it not have been for government support. Markups in 2020 and 2021 were probably higher than model estimates so Figure 3.3 shows only the percentage difference in markups between 2022 and 2019.

  8. The analysis excludes firms not reporting at least one of the following items: employment, employee costs, assets, tangible assets and sales. The sample also excludes firms reporting one of the listed items equal to zero. Also excluded are all activities the first two digits of which are greater than 82 such as public administration, defence, education, health, etc. These criteria are used in all the calculations in this blog.

  9. Relative to 2021, net profits rose by 23%, EBITDA by 27%, operating profits by 25% and employee costs by 14%.

  10. Colonna, F., Torrini, R. and Viviano, E. (2023): The profit share and firm mark-up: how to interpret them? Banca D'Italia Occasional Paper No. 770, May

  11. According to economic theory, the developments in the costs of variable inputs to sales ratio are inversely proportional to developments in markups, provided there have been no recent big changes in production technology (De Loecker and Warzynski, 2012, De Loecker et al., 2021). In addition, assuming labour and intermediate inputs are variable production factors, the developments in the shares of their costs in sales are inversely proportional to developments in markups.