The Profit Share and Firm Markup: How to Interpret Them?

Abstract

This paper discusses, theoretically and empirically, the relationship between two indicators: the profit share in value added and markups. While many commentators simply interpret the profit share as a proxy for markup, we show that with a production function with two inputs (i.e. labour and intermediates), the profit share can increase even if markups remain constant or diminish. This occurs when intermediate input costs grow faster than labour costs (as in the current economic situation) and input substitutability is limited (as with energy and labour, in the short run). Unfortunately, markups cannot be easily calculated using national accounts data, but approximate data are available for some sectors in Germany and Italy. We can thus show that markups in industry and in manufacturing remained constant in Germany in 2022, but increased considerably in construction, retail, accommodation and transport. In Italy, instead, markups returned to their pre-pandemic levels following a series of adjustments during the health emergency.

Keywords: markup, profit shares, inflation

JEL Classification: E25, E30