On allexperts.com, we find the following query:
How can I find a list of retail markup % by industry? My husband won’t let me buy new lamps because his mother worked in a lamp store 60 years ago and the markup was “astronomical”. I’m betting that there are plenty of things he buys that have a similar markup as do lamps. I know that the average markup varies between industries (i.e. groceries being very low). Appreciate any insight! Thanks!!!!
Several questions arise, or which the most compelling is: When you buy a lamp, why would you care about the markup, as opposed to, oh, say, the price? In fact, if you’re the sort of person who worries about things like minimizing your carbon footprint and otherwise curbing your resource consumption, you should of course prefer items with high markups, since the markup is the part of the price that doesn’t reflect resource consumption. Or to put this another way: Given the price of the lamp, isn’t it better for the seller to earn more profit rather than less?
Since economic theory tells me that the author of this inquiry is perfectly rational, I see only a small number of possibilities:
- Misanthropy. This is a person who likes consuming as many resources as possible, in order to make the world a grimmer place for the rest of us.
- Long-term thinking. Taking as given the seller’s ability to command a high markup, it’s better to buy the lamp than not to. But buying the lamp gives other sellers an incentive to expend resources on acquiring market power, which we wouldn’t want to encourage.
- Historical perspective. The author of the inquiry is aware that the power to command high markups rarely survives for more than about 60 years. Since the markups in the lamp industry were high sixty years ago, we can expect cheaper lamps in a year or two.
I welcome your alternative theories. Hat tip to Pete Klenow.
“Given the price of the lamp, isn’t it better for the seller to earn more profit rather than less?”
That is a great line. Very insightful. Too bad non-economists won’t understand it.
I think that line Bryan quotes gets kind of to the heart of the disagreement. Consider two sources of lighting, A and B, which cost the same, but the maker of A makes more profit per unit than the maker of B. Given the same quality, that implies that maker A either is able to get a better deal on materials or is more efficient at producing and distributing A. That’s fine and dandy and your conclusion is sound that you should prefer to deal with the more efficient producer. What if instead the alternative is A and A’, where A’ is used A, so it is of the same quality originally but may have some defects from use. It is likely that A’ is significantly cheaper than A, since not many would pay full prices for used lamps. Depending on how used A’ is, it might be a much better deal where the husband is not sacrificing much quality in exchange for a price that lower. Obviously, this also extends to buying a used iPod instead of the newest one, on account of the massive mark-up Apple offers.
I have a friend who works for a lamp company. Says it’s a very shady business.
“Given the price of the lamp, isn’t it better for the seller to earn more profit rather than less”.
OK I must not understand this. If I care about curbing resource consumption than why is it better to transfer wealth from me, who has complete control over what it gets spent on, to someone else? If I worry about resource consumption I want the lowest profit margin possible and I’ll put my consumer surplus in the mattress.
@Andy B,
He’s speaking in terms of a fixed price. If you were paying the same price for the item, but it had very little markup, that cost would indicate a scarcity in a product rather than an abundance as opposed to the high markup case.
I’m guessing the husband thinks that the old lamps in the house are just fine, and the mark-up argument is just an excuse because he wants to spend the money on something else that he wants, like say an iphone.
I will have to remember to use that one myself. Mark up–that’s good.
Assuming that the the high mark-up on lamps is real and has lasted 60-years then it is likely because some government regulations are allowing lamp-makers to make monopoly profits.
Perhaps the husband is an Austrian economist and is taking a stand on govt intervention in the lamp industry ?
Is this really so difficult to understand?
People hate to feel cheated. Few people want to buy something and then find out that they paid, say, double what the item cost to produce. Is this feeling “rational”? By the definition of economists, probably not. But it is easily understandable by most people, I think.
Also, it may be practical. Given two lamps that are sold in two different stores for the same price, which lamp should you buy? Assuming the consumer has no way of measuring the quality and reliability of each lamp, then if you know the markup, it would be practical to buy the one with the lower markup, since it presumably has higher quality materials and/or better manufacturing and quality control.
“I can get it for you wholesale.” That is, you believe you have access to a source not generally available who can get the item at a price without the same mark up. Your husband will ask his cousin in Jersey to get the lamp for you.
This is not entirely implausible. I routinely drink wine at home, after a dinner, having foregone the pleasure of making everyone else’s life better and greener by paying the restaurateur’s mark up.
Of couse I am misanthropic so maybe that’s a bad example. I am in fact just off to consume a coffee and so deprive some future buyer the cahnce of drinking it.
@Andy B: If I buy 8 oz of orange juice that might take 4 oranges. So let’s say it costs 4 times the cost of an orange plus $1 mark up. Or it might take only 2 oranges. At the same price then with a higher mark up, fewer oranges died for my drink. If I am green or generous, then I should *prefer* that, at the same price, to the sacrifice of 4 whole oranges.
High lamp markup means that (1) the lamp will have poor resale value, and (2) I will have to expend a lot of effort to get a good deal. So yes, I say that markup is a consideration when shopping.
@KenB : But then the recipient of the higher markup just uses his profit to buy up and consume those 2 ‘saved’ oranges (or the equivalent). So where’s the gain ?
I think their response would almost certainly be that they don’t appreciate the seller of the lamp transferring wealth from the buyer to themselves. You can call it a sense of fairp lay, or you can call it spite when things don’t swing your way, but uneven outcomes tend to incite anger in humans regardless of other considerations. In this case, the righteous anger the allexperts.com lady felt outweighed the consumer surplus she could have captured by buying the lamp.
It is true that for two products which are identical except for markup (including identical in price), you should prefer the one with the greater markup. But the idea is that a product has a more or less fixed cost of production. To a first approximation, then, you can’t have two products which are identical except for markup, because they can be expected to have about the same pre-markup price, so if they have different markups the one with the greater markup will have the greater price. Under these circumstances having a high markup is a proxy for having a high overall price. Also, having a high markup is specifically a proxy for having a price higher than that which will result after price shakeouts due to competition (since competition should reduce markup through price wars).
Of course, you may disagree that a lamp has a more or less fixed cost of production, but it’s at least plausible as what the husband meant.
That explains why people may prefer low markups in general, but the 60 years in the original raises other questions. If high markup is being used as a proxy for prices higher than would result from market competition, a statement that “these products have had high markup for 60 years” is equivalent to a statement that competition over 60 years has not reduced the prices of the product to what one would expect. That is not nonsensical; one possibility is that the industry is controlled by a cartel with high barriers to entry, government regulations, or other non-market forces. Another possibility is that many consumers are price-insensitive and competing by lowering the price of your lamps doesn’t work.
She should ask her husband to go ahead and make her some lamps, especially ones that look like the what she wants.
Related to Ken B’s point, perhaps average markup is related to price dispersion. Or bargaining power. Maybe the writer is saying “My husband won’t let ME buy….” There’s some evidence that men and women get different prices on average when bargaining is involved. And most durable goods prices are negotiable.
60 years ago, lamps in lamp stores had high markups. But now, many buy lamps in Ikea, Home Depot, Target, or other mass market outlets that likely have much lower markups, which should make her husband feel better.
Rob Rawlings:
But then the recipient of the higher markup just uses his profit to buy up and consume those 2 ‘saved’ oranges (or the equivalent). So where’s the gain ?
The gain is that the recipient gets to eat two extra oranges.
@Bob Rawlings: I see Steve beat me to the punch. Remember I said (echoing Steve) green or generous. The ‘gain’ is either the oranges live to see another day (green) or someone other than me gets to drink their life’s blood (generous).
@mhenner: Maybe Target, Wal-Mart, or Ikea are those secret outlets where he can get it wholesale, but which the general public doesn’t know about!
A woman rushing to a job interview is caught in the rain and her hat is ruined.
She sees a hat shop, but nothing fits.
“No problem” says the milliner, and he whips together a creation with a yard of ribbon and a bobby-pin.
“Prefect!” she cries, “How much?”
“$40”
“Forty dollars for 10 cents worth of ribbon?” she gasps, “Outrageous!”
The milliner takes the hat, pulls out the pin, snaps his wrist and the ribbon unfurls. He hands it to her.
“The ribbon, madam, is free.”
Steve/Ken,
But if you’re truly green (and not generous) you want to minimize the total consumption of resources for you and the lamp-guy combined. You can minimize your consumption by paying a bigger mark-up but if he just uses his profit to consume then you have not reduced total consumption.
You would be better off buying goods with a low-mark up and burning the money you save or (even better) just work less hours and only buy things with low mark-ups.
@Bob Rawlings: You are missing my either or. EITHER the tow orages are not consumed OR somebody else consumes them. If what I really care about is the benefit of others, not myself, then that should be a plus for me. I have consumed fewer oranges. More for the rest of you.
Ken, I got that. I was making an additional assumption that most green-thinking people would not consider a solution that meant that they just transferred their unused “carbon footprint” to someone else very green.
“Since economic theory tells me that the author of this inquiry is perfectly rational…”
Well, there’s your problem. ;-) People are rarely perfectly rational economic actors. I know you’ve read Thinking, Fast & Slow — when this man learned about the wholesale prices for lamps, that became a subconscious “anchor point”. Once his mind got stuck using that anchor to judge the retail price, he felt like he’s being ripped off.
I guess my reaction to this and the previous comments is that I think it’s odd to take price as a given. If there exists any wholesaler or online used lamp seller who can offer a new-quality lamp for less than a store price, then it may be prudent to explore those options. The opportunity cost of finding a lamp at a mark-up near zero could be much lower than the store mark-up. That might be what the husband is referring to.
The most obvious and rational reason for the husband’s view just occurred to me.
The reason that some lines of retail business can charge higher mark-ups is that their sales staff add value by providing expert guidance on the product line to ensure customers make the optimal choice.
The husband, coming from a family with inside knowledge of the lamp trade, would not need to pay the mark-ups as he does not need that specialist knowledge so can optimize by buying used.
Rob Rawlings:
But if you’re truly green (and not generous) you want to minimize the total consumption of resources for you and the lamp-guy combined. You can minimize your consumption by paying a bigger mark-up but if he just uses his profit to consume then you have not reduced total consumption.
Wait a minute. I thought the whole point of being green was to lower your resource consumption *so that there will be more resources available for others*. Otherwise, what’s the point?
Given that you spend $100 on a lamp, the choice is between a lamp that uses up $100 worth of resources, and a lamp that uses up $60 worth of resources, leaving $40 worth for the lamp guy. If you care at all about the lamp guy, surely you’ll prefer the latter.
You would be better off buying goods with a low-mark up and burning the money you save or (even better) just work less hours and only buy things with low mark-ups.
How does burning money help? All this does is reduce your own command over resources, leaving more resources available for others — but you’ve already indicated that you don’t want others to consume those resources. The only way to reduce total resource consumption is to destroy actual resources, not to burn money.
In more detail: If you burn money, you lower the price level (by a tiny amount), increasing everyone else’s purchasing power (by a tiny amount); multiply this by hundreds of millions of people and the $40 you’ve burned transfers $40 worth of purchasing power to others, who then consume an additional $40 worth of resources. Why is this any different than just buying the lamp with the high markup and letting the lamp guy consume those resources?
If your goal is to reduce resource consumption, you’ve got to go out and do things like burn people’s houses down. If your goal is to consume less yourself so that others can consume more, then buying the lamp with the high markup is a good way to do this.
Pete:
I guess my reaction to this and the previous comments is that I think it’s odd to take price as a given.
On the contrary. This woman has been shopping for lamps. I think it’s a fair assumption that she’s observed the price.
On second thought, rereading your comment, I think what you’re saying is that the existence of a high markup tells you that there are likely to be better bargains elsewhere and it’s worth shopping for them. Point taken.
Rob Rawlings:
The reason that some lines of retail business can charge higher mark-ups is that their sales staff add value by providing expert guidance on the product line to ensure customers make the optimal choice.
The husband, coming from a family with inside knowledge of the lamp trade, would not need to pay the mark-ups as he does not need that specialist knowledge so can optimize by buying used.
Your earlier comments seemed off base to me, but I like this one very much.
@ Ken Aromdee #13,
Natural Monopolies can result in free markets in industries which produce economies of scale as well. In this case government intervention or perfect price discrimination on the part of the firm would be necessary to achieve the optimal profit level.
Steve,
On “Wait a minute. I thought the whole point of being green was to lower your resource consumption *so that there will be more resources available for others*. Otherwise, what’s the point?”
I think that they want to conserve resources now so that future generations can consume more not others in the present. In any case , assuming they do in fact want to reduce total consumption in the present, I agree that burning money would not work for the reason you state (unless one drags in sticky price assumptions in which case some resources would go unsold and not be used up).
But on “The only way to reduce total resource consumption is to destroy actual resources, not to burn money.”. I disagree this is the only way. Declining to work the extra hours that would be needed to earn the extra money would reduce resource consumption without “destroy(ing) actual resources”. In total less would be produced and consumed as a result – other things being equal.
Isn’t the markup, in a perfectly efficient economy, also due to resource consumption? After all, won’t the markup just be enough to cover the rent, utilities and wages?
My guess is that lamp stores do not charge a particularly high mark up (and didn’t 60 years ago either!). Selling lamps is probably low volume and therefore stores have to charge what appears to be a high mark-up to cover rent, wages and other costs of selling lamps. Grocery stores, on the other hand, have huge volume and therefore rent and wages etc are spread over thousands of sales and are therefore low on each individual sale.
This is why a lot of stores are moving online. In the UK big electrical stores like Comet have closed recently. Comet had to charge high mark-ups on TVs, laptops etc to cover the costs of running the store but internet companies have lower costs and drove Comet out of business.
The original comment says, “My husband won’t let me buy new lamps because his mother worked in a lamp store 60 years ago and the markup was “astronomical””, as already explained the high mark-up covered the costs of running the store including his mother’s wages. Her husband’s policy would have made his mother lose her job if people had enacted it 60 years ago. Nothing like the love for one’s mother!
Would it be rational for many people to spend the time and effort needed to learn enough about economics to avoid making this person’s mistake? Whatever rationality means, it can’t mean “perfectly informed about all the things that can affe3ct your life.”
@32 and 33, you might be right, but the definition of a markup is that it’s the price above which it costs a producer to produce, so any “markup” would technically have to be for profit. It all depends on how competitive an industry is for how much of a markup they can add.
I posted something of a longish response here:
http://euvoluntaryexchange.blogspot.com/2013/02/anti-profit-bias.html
I’m not generally enamored with ecological rationality stories, since they’re a little too pat, but the non-economists I speak to seem to be genuine in their hostility to profits.
“Since economic theory tells me that the author of this inquiry is perfectly rational, I see only a small number of possibilities…”
Economic theory doesn’t teach us that people are rational; it makes the simplifying assumption that people are rational, and draws conclusions that are consistent with practice.
I had the same problem with a Yale professor on game theory, whose (my new favourite word) lectures are freely available on-line. When discussing Spence’s model of signalling and education, he claims that the model tells us that an MBA degree don’t actually make a graduate a more valuable professional. No. MBAs might very well have actual educational value. Spence only says that it is not necessary for an MBA to have educational value to signal that a degree holder is a better employee. It is sufficient that it is difficult to acquire.
1. I don’t know if people have made this point, I only know that it has not been responded to.
2. I’m not 100% sure if my point is true; it’s more of a sketch of an idea than an argument or attack or whatever.
-> Surely “mark-ups” are prices for resources used – and higher mark-up means more spent on rent to keep the shop in a more convenient (but more useful for other projects as well) area, better staff (but also better at other tasks, jobs etc.) So an approach which attempted to reduce mark-up was aimed at reducing consumption.
(BUT: not as much as one that tried to reduce total price, because that accounts for all resources used – which is one of the main pros of the price system and free markets; they make people bear the costs of their actions.)
@31: no matter how you slice it, if the glass you drink took 2 oranges *your* footprint is smaller than if it took 4 oranges.
Dr. L
No light to shed but another example. About 30 yrs ago, plastic slippers for girls enjoyed a moment of fashion. A friend with a daughter of susceptible age wanted a pair. They were much cheaper than regular shoes but my friend wouldn’t buy them for his daughter.
His reason was: Though the slippers were 1/5 the price of shoes, he knew the slippers had less than 2 cents worth of plastic. The “markup” (not allowing for manufacturing, transportation and merchandising) was therefore too high.
It sounds like that poor lady has gone a long time without a new lamp. The husband is clearly not valuing her needs as highly as his own. Maybe it’s time for her to go to the market and find someone who won’t so stubbornly value his own needs over hers?
Isn’t the markup, in a perfectly efficient economy, also due to resource consumption? After all, won’t the markup just be enough to cover the rent, utilities and wages?
@32 and 33, you might be right, but the definition of a markup is that it’s the price above which it costs a producer to produce, so any “markup” would technically have to be for profit.
Is it possible to profit – except via rents – in a perfectly efficient market?
34: “Whatever rationality means, it can’t mean “perfectly informed about all the things that can affect your life.”
Ah, but in economic terms, it does. As No. 37 says, economic theory does not tell us that people are rational, but that rationality is necessary for economic theory to work. SL has his tongue firmly in his cheek here, perhaps? It is possible that one of the rational explanations is correct, or he may just have made a mistake, or possibly a “deliberate” mistake.
The answer to the original question has a link to a place where you can check benchmarks for different retail sectors, including gross margin.
http://www.retailowner.com/Benchmarks.aspx
@Harold: No economic theory I’ve ever seen says that. Information, like other goods, is costly, so perfect information on all subjects would be infinitely costly. A rational person wouldn’t spend more to acquire information than that information would be worth to that person. Only in Coase’s nightmare world of zero transaction costs would everyone be perfectly informed. Consider, for instance, the economic analysis of voting, which starts with voters, rationally, deciding to be ignorant because it would not pay to acquire the information they’d need to vote intelligently.
To be sure, some economists seem to forget this on particular occasions, which is why Coase doesn’t get the attention he deserves (except from lawyers, who mostly don’t understand what he was saying and who therefore thing that the obvious part of the “Coase theorem” is surprising).
I’ll go with the idea that the behavioral finance crowd has found another data point here. Some people apparently view a higher markup as “less fair” irrespective of total price.
Alan Gunn – if we could only find a way to direct people to websites like this one, the search costs for correcting their errors should be much lower?
Alan Gunn (44) “@Harold: No economic theory I’ve ever seen says that”
This is something that has come round a few times, and perhaps we can get it cleared up. Obviously perfect information is impossible, but that does not mean that economic theory does not require it.
From Wikipedia, about Pareto efficiency:
“Under certain idealized conditions, it can be shown that a system of free markets will lead to a Pareto efficient outcome. However, the result only holds under the restrictive assumptions necessary for the proof (markets exist for all possible goods so there are no externalities, all markets are in full equilibrium, markets are perfectly competitive, transaction costs are negligible, *and market participants have perfect information*). In the absence of perfect information or complete markets, outcomes will generically be Pareto inefficient, per the Greenwald–Stiglitz theorem.[3]”
Therefore economic theory says clearly that for Pareto efficiency, perfect knowledge is required. In the absence of perfect knowledge, the result *must* be Pareto inefficient.
Economists of course know that perfect knowledge is impossible, and therefore that in the real world we are dealing with market failures of one sort or another. However, acknowledging that there is a problem does not make it go away.
Examples are cited about insurance and information asymetry, but there is some degree of imperfect information in every choice you make.
When buying toothpaste, you do not know exactly the relative effects of one brand over another, so you make a choice based on your best guess. This has less than full information, so the result will be different from the Pareto equilibrium. As far as I can see, there is no way to get any closer without imposing even greater costs, so your best guess is probably as good as we can get. In the longer term, education is probably the best way to get us a s close as possible.
There are other situations when imperfect information may cause more harm – SL has pointed out the fallacy of using “food miles” as the main reason for choosing products, but many people do this. Again education is the best option – keep it up Steve.
Other people point out that buying fast cars may not bring the happiness you think it will. Maybe they are right, maybe not, but it is true that you do not know the utility that the car will bring over the time you own it. Imperfect information of a different sort.
Whilst I am fairly certain that economists acknowledge that perfect information is impossible, I am not sure how far they generally go in accepting what is imperfect information.
Saying that Pareto efficiency requires perfect information is hardly the same thing as saying that economic theory assumes that people have perfect information. It’s just a way of saying that the world is not Pareto efficient. Nobody I’ve ever met, economist or regular person, thinks it is. Your argument resembles Krugman’s saying that we haven’t been spending too much for 20 years because we haven’t had deficits in all those years.
The cost of obtaining information is something economists study. Indeed, it is central to such things as Hayek’s paper on the use of knowledge in society, voting behavior, transaction cost economics, and lots of other things. If, as you claim, economic theory tells us that everyone has perfect information, all these fields could not exist.
@Mike H.
Economic profit is impossible in a perfectly competitive market.
Alan Gunn. Looking back I see rationality can exist separately from perfect information, so my point as stated was incorrect – rationality does not require perfect information. However, perfect information is certainly one of the assumptions of economic theories.
Perhaps you can help me here. Basic theories of markets assume perfect knowledge. This is essential for the outcome. More developed theories assign a cost to information, and therefore treat information as a marketable good. Is the information needed for the basic market theories to work treated separately from the information that is a good? For example, you say “A rational person wouldn’t spend more to acquire information than that information would be worth to that person”, but how does economic theory deal with the fact that in a world of imperfect information, nobody can know how much the information is worth to them? Does it assume there is perfect information about how much the information is worth. If so, it is dodging the issue, and if not, how does it resolve this?
No economist assumes perfect knowledge, even for “basic theories.” You cite nothing and make no argument that’s not simply an assertion. There is no point in continuing this exchange.
I missed this thread when it first started, but I would like to pose a question. In the U.S., the commodity that has the highest markup is text messages. Cell phone users often pay $10 or $15 per month for some number of text messages, say 1000. That works out to $0.01 per text, even though the marginal cost to the wireless carrier is less than 1/10 of a cent. Thus, the markup is perhaps 1900%.
Why does this markup persist? Why doesn’t competition lower the cost? The cost of text messages has lowered somewhat over time, as on my first cell phone I paid $0.10 per text, which was a markup of around 20,000%. But still…
If you model a repeated game you can easily see that markups matter.
Define the game – Store (S) secretly sets markups for observably identical products L1 and L2 so that L1 and L2 are priced the same but L1 has markup of 10$ and L2 has markup of 50$. Buyer (B) then makes a move and buys either L1 or L2. As L1 and L2 are observably the same, expected payoff for B is the same which makes B indifferent. If you as B are aware of imperfect information you randomize p/1-p (I would take p=0.5) over which product to buy. Payoff for S (PS1) = 0.5*10+0.5*50 = 30. Assume that payoff for B (PB1) is X1. This setup is a Nash equilibrium, so S will not change markups.
Now make markup information public. In this case you can discriminate and only buy L1. That gives S payoff of 10. Additionaly – this setup makes markups L1:10$ and L2:M$ (10 < M < 50) also a Nash equilibrium. If S then switches to L1:10$, L2:40$ (remember, S is indifferent to this switch, it does not cost him anything) then B immediately switches to buying only L2. Result – payoff for S (PS2) = 40 = PS1 + 10, payoff for B (PB2) = X + 10 = PB1 + 10.
As you can see, choosing the lowest markup can allow a way out of a Nash equilibrium towards Pareto improvement.
You might argue that this is not a perfect model but it might well be the one that this guy was playing in his head.
Alan Gunn:
I did cite Wikipedia “However, the result only holds under the restrictive assumptions necessary for the proof…and market participants have perfect information” Note the word “assumption” and “perfect knowledge”.
I am sorry I have failed to communicate my point.
Reading Hayek’s paper, I realise where I have been unclear. By perfect information, I mean information about the choice to be made and the effect on the individual.
From Hayek: “he possesses unique information of which beneficial use might be made”
It is this information which is assumed to be perfect, I think. I was not intending to suggest he must know everything, but he must know the efects of his choice on himself.
Hayek himself seems to agrre with me about the assuption of perfection required by thetheories:
“Of course, these adjustments are probably never “perfect” in the sense in which the economist conceives of them in his equilibrium analysis. But I fear that our theoretical habits of approaching the problem with the assumption of more or less perfect knowledge on the part of almost everyone…”
In the original post, Steve is “assuming” such perfect knowledge when he assigns the possible reasons why the man is reluctant to buy a lamp. The reasons given are consistent with rationality and perfect knowledge. An alternative explanation – (that the man erroneously believes he is being ripped off by lamp shops, and so his money will get him more value spent elsewhere), is difficult to incorporate into economc theories. He is lacking in information, and so makes an inefficient choice – one that does not acheive his goals
JVA -one question, if the store ownwer can sell two indistinguishable products at different markups, why would he bother to stock the one with the smaller margin?
Al: Text messages are generally not available as a standalone product, but bundled with other products with larger costs. The bundle behaves like a single item on the market, and the bundle doesn’t have a markup of 1900% even though one of its components does.