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Old 06-27-2013, 04:19 PM   #79
Fedaykin
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Quote:
Originally Posted by Pony Boy View Post
I didnít say my income doesn't go up and down, I said my profit margin stays the same, do you know what a profit margin is?
Your profit margin will not stay constant if you increase price unless you have a product/service with 100% inelastic demand.

profit margin = (revenue - cost)/revenue

Lets do the math, shall we?

Scenario A (original setup):

Cost: (employee salaries, equipment, etc.): $10,000
Sales price of item: $100
Number of items sold: 1000
Revenue: $100,000

Net profit: $100,000 - $10,000 = $90,000
Profit margin: (net profit)/revenue = 90%

Scenario B (increase in employee costs that you don't try to pass along)

Cost: (employee salaries, equipment, etc.): $20,000
Sales price of item: $100
Number of items sold: 1000
Revenue: $100,000

Net profit: $100,000 - $20,000 = $80,000
Profit margin: $80000/$100000 = 80%

Scenario C (increase in employee costs that you do pass on by raising prices to maintain profit margin)

Cost: (employee salaries, equipment, etc.): $20,000
Revenue required to maintain a 90% profit margin: $200,000 (remember your algebra?)
Sales price of item to maintain profit margin: $200 (double the price!)
Number of items sold: 1000
Revenue: $200,000

Net profit: $200,000 - $20,000 = $180,000
Profit margin: $180000/$200000 = 90%

Look, you have the same profit margin. You're so right! I bow to you!

OH WAIT: Scenario C assumes the raise in price didn't affect the number of units sold even with increases in prices!

Of course, my example uses big numbers, but the principal is the same no matter the actual numbers involved. You CANNOT maintain a constant profit margin increasing prices to offset costs unless that you have 100% inelastic demand. Especially since maintaining net profit margin doesn't mean simply directly offsetting the extra costs, but maintaining that ratio (hence the necessity to add $100,000 to maintain a 90% margin with only a $10,000 increase in cost) You can mitigate profit margin reduction, but you can't maintain. Full Stop.


Pretty sad I have to explain this to a "highly successful business owner". This is econ 101 bub.
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