Economic chart showing markup expansion during supply shocks
governance

The Profit-Price Channel: How Market Power Turns Shocks into Inflation

Sol Meridian ContributorsJuly 1, 202525 min

Between what we pay and what it cost to make runs a corridor of hidden doors—contracts, fees, platforms, habits—where a quiet arithmetic decides how much of a shock becomes a price and how much becomes a profit. The profit-price channel, mapped with equations and evidence.

In the museum of prices there is a room without windows where every object is labeled with two names. The first is what we pay. The second is what it cost to make. Between those two labels runs a corridor of hidden doors—contracts, fees, choke points, platforms, habits—where a quiet arithmetic decides how much of a shock becomes a price and how much becomes a profit. Guides call this corridor the profit-price channel. Tourists call it greed. Economists, who distrust single words for crowded phenomena, map it instead.

This essay is a chart for that corridor. We will not accuse grocers or absolve oilmen; we will diagram the transmission of shocks through market power. We will show how concentration, contracts, and platforms behave like amplifiers; how firms learn to keep what began as insurance; how "temporary" spreads acquire rights of citizenship in the ledger. We will write the algebra in clean lines and carry it, like a lantern, through the aisles of meatpacking, freight, and app stores—and through the empirical record of Spain's energy shock, Mexico's tortilla inflation, and Chile's supermarket cartels. Where moralists say why, we will ask how much, and by what mechanism.

I. The Equation Behind the Price Tag

A useful fiction:

$$p_t \;=\; \bigl(1+\mu_t\bigr)\,\bar c_t\,,$$

where $p_t$ is the price at time $t$, $\bar c_t$ is unit cost (materials, labor, logistics, financing), and $\mu_t$ is the markup. In tranquil times, $\mu_t$ behaves like temperament—industry custom moderated by rivalry. In agitated times, $\mu_t$ is a decision: an assertion about bargaining power wrapped in the language of "discipline," "volatility," or "input normalization."

The profit-price channel is the set of gears that move $\mu_t$. If a shock raises $\bar c_t$ by $\Delta c$, a firm may pass through some fraction $\theta$ to price and add a surcharge $\sigma$ to $\mu_t$ because the storm makes that addition narratively acceptable. The realized change in price is then

$$\Delta p \approx \theta\,\Delta c \;+\; \bar c\,\sigma.$$

When shocks recede, $\bar c_t$ falls; whether $\mu_t$ returns is the whole drama. In many concentrated sectors, $\mu_t$ shows stickiness that macro textbooks treat as a footnote but households experience as a new normal. What began as a storm fee becomes a habit.

II. A Transmission Line, Drawn Plainly

A shock—war, drought, bottleneck, rate spike—arrives. It does not travel alone; it takes the form of particular scarcities: a queue at a port, a missing input, a factory idled by flooding, a currency's lurch. The profit-price channel carries this impulse through five stages:

  1. Structure: Who owns the corridor? Concentration $\kappa$ (share of top firms) and the density of platform tolls (app fees, payment rails, ad auctions) shape the room in which pricing occurs.

  2. Contracts: Long-term supply deals, most-favored-nation clauses (MFNs), category captaincy in retail, and slotting fees. These define who may move first and who must follow.

  3. Coordination devices: Public list prices; benchmark indices; algorithmic pricing engines trained on rivals' signals. These aren't collusion; they are metronomes.

  4. Narrative cover: Earnings scripts, analyst expectations, and "temporary surcharges." Narrative multiplies permission.

  5. Persistence: Menu costs, reference prices, and debt covenants. The machinery that defended margins in the storm becomes the norm in the calm.

Across these stages, what starts as cost pass-through becomes markup acquisition. The corridor does not invent shortage; it decides how much of shortage is monetized.

III. Five Mechanisms That Thicken Markups

1. Concentration with Capacity Discipline. When four firms hold most of a shelf or a route and each knows the others' balance sheets, output is a chess game. In shipping, airlines, meatpacking, even some chemicals, capacity is the true instrument. A cost shock arrives; capacity is not expanded; prices climb beyond pass-through; margins improve "to offset volatility." The improvement lingers because nobody wants to be first to cut.

2. Contract Architecture. Retailers install category captains—favored suppliers who advise on planograms, promotions, and sometimes wholesale price recommendations. The captain's fees and slotting claims must be recovered; they are recovered in the price. MFNs at the wholesale or platform level stabilize relative prices and slow competitive undercutting; algorithmic engines treat those constraints as axioms.

3. Platform Tolls. App stores, ad markets, payment rails—these are quasi-states that tax transactions and license access. A developer absorbing a 15–30% commission on digital sales confronts a different markup frontier than a grocer. During shocks, platforms seldom lower tolls; sellers raise prices to honor the gate. When the shock ends, the toll remains. It is not "greed"; it is governance without ballots.

4. Financial Covenants. Debt has a voice. Firms with leverage face interest-coverage and net-debt-to-EBITDA tests. A sudden input shock paired with higher rates produces an imperative: protect margins to keep covenants. Sales teams call it "price integrity." In practice—especially in concentrated industries—that means $\sigma > 0$ even when $\theta$ would have sufficed.

5. Reference-Price Hysteresis. Consumers learn new anchors slowly. If price rose from 10 to 12 during a storm and falls to 11 when costs normalize, many will register "a relief" rather than "a retained gain." Firms study this psychology and set $\mu$ accordingly. What looked like a surcharge becomes a plateau.

Each mechanism on its own is lawful. Together they form a privileged path for turning shocks into durable spreads.

IV. The Evidence, Transatlantic and South

United States: A markup-led first act

Spain and the euro area: Profits, energy, and the Iberian mechanism

Latin America: Staple markets, dominance, and state bargaining

Across these cases, the pattern repeats: where sectors are concentrated and switching is costly, shocks translate into profit-heavy inflation; where policy targets the bottleneck (Spain's gas-power decoupling) or the dominance (COFECE), pass-through shrinks.

V. The Aisle, the Ocean, the App

Walk three corridors.

The Aisle. In a supermarket, a dozen contracts make a price. There are wholesale list prices, promotional allowances, end-cap fees, slotting, and data trades (retail media rebates). After a shock to grain or freight, the brand raises its wholesale; the retailer raises shelf price a little more; both sides cite shrink and wages. Promotions shrink in depth or frequency. When the shock abates, promotions return but list and shelf do not, because the mix has changed: more "premium" lines, smaller sizes, "new recipes." The category's average markup is rebased. Spain's CNMC VAT study showed exactly this: imperfect pass-through where concentration was high.

The Ocean. Ocean carriers once suffered from ruinous cycles. Consolidation and alliances disciplined capacity. A shock to ports and boxes turned queues into windfalls; surcharges proliferated. When queues eased, carriers did not forget. Contracts now contain escalation ladders and indexation that defend yields; customers have learned to sign them. Freight rates fall, but the floor is higher.

The App. A developer sells a subscription through a platform that charges a toll and governs identity, updates, and discovery. A shock to ad prices or data privacy makes customer acquisition costlier; the developer raises price to shield unit economics after the toll. The toll is not a shock; it is a cliff. With few distribution alternatives, the markup remains—even when ads cheapen—because the platform remains.

Three places, one logic: the corridor writes habits in crisis ink and reads them in peacetime as scripture.

VI. The Markup Weather Map

To move beyond metaphor, imagine a Markup Weather Map. For each sector $s$, estimate $\Delta \mu_s$ across a shock window and a normalization window. Decompose

$$\Delta \mu_s \approx f(\kappa_s,\ \phi_s,\ \psi_s,\ \lambda_s),$$

where $\kappa_s$ is concentration, $\phi_s$ denotes contract density (MFNs, long-term indexation, captaincy), $\psi_s$ captures platform toll exposure, and $\lambda_s$ records leverage/covenant pressure. You are not searching for villains; you are building a transfer function: shock in, markup out.

Such a map distinguishes scarcity inflation (pure $\Delta c$) from market-power inflation (nonzero $\Delta \mu$). It guides policy like a weather office: do we need ships or subpoenas; storage or hearings; a harvest or a cap?

The empirical work already exists in pieces: the Kansas City Fed's markup decomposition for the U.S., the ECB's unit-profit bulletin for Europe, Spain's CNMC sectoral studies, Mexico's COFECE market-power diagnostics. The task is to unify the methodology and publish quarterly.

VII. The Algebra of Persistence

Why does $\mu$ stay high after $\bar c$ recedes? Because three frictions tie it down.

Menu Costs and Systems. Changing prices is not free: labeling, ERP rules, promotional calendars, trade allowances. The trivial "menu cost" in macro textbooks becomes a nontrivial coordination cost in firms that synchronize thousands of SKUs.

Investor Narratives. Once a firm has demonstrated a margin step-up and told a story about "category mix" and "revenue management," the story itself becomes a covenant. To unwind it is to confess the gain was opportunistic. Many firms prefer the silence of persistence to the noise of reversion.

Common Knowledge of Restraint. If all large players demonstrated restraint during the storm and enjoyed the same arithmetic, each expects the others to defend it. No one has to speak; the index speaks for them. Isabella Weber and Evan Wasner call this sellers' inflation: a micro process where cost shocks legitimize coordinated markups, documented both in pricing data and in the rhetoric of earnings calls.

The corridor, in other words, has memory.

VIII. The Receipt Standard

Adopt a standard akin to the nutrition label, for firms above a threshold:

The label is audited annually, more often during emergencies. Like calories, the numbers are imperfect but comparable. Investors will ask better questions; journalists will stop guessing; consumers will at least know which god to curse.

IX. Beyond Moralizing: Instruments, Not Incantations

If the diagnostic is a weather map, the remedies are meteorology, not magic.

1. Contract Cleanups.

2. Platform Governance.

3. Competition Remedies.

4. Bottleneck Decoupling (the Iberian Lesson). Where one input (gas) sets an entire system's marginal price (power), allow temporary price caps for that input in the system, with compensating payments and monitored incentives to economize. The Spanish–Portuguese "Iberian exception" shows that precise intervention can cut pass-through without killing markets.

5. Grocery Channel Neutrality. Mandate pass-through reporting for VAT changes and staple subsidies; curb exclusivity and slotting practices during declared price emergencies; empower competition agencies to order targeted divestitures where upstream dominance (corn flour) drives a national staple (tortillas). Mexico's COFECE playbook points the way.

6. Covenants with Teeth, for Emergencies. In declared supply emergencies, require large sellers to publish a Price Decomposition Receipt: $\Delta p = \theta \Delta c + \Delta \mu + \Delta \text{mix}$. Temporary windfall taxes are crude; temporary decomposition mandates are surgical. If $\Delta \mu$ does the lifting, sunlight will do the flogging.

7. Resilience Instead of Righteousness. Subsidize inventory buffers and redundant suppliers in key inputs. Scarcity that never arrives cannot be monetized.

None of these instruments abolishes profit. They abolish ambiguity.

X. The House of Algorithms

An unheralded amplifier in the corridor is the pricing engine: software that ingests costs, competitors' signals, and demand estimates and proposes price. When every large player runs engines trained on the same public cues (leader's price, benchmark index, holiday timing), synchronization occurs without conspiracy. The remedy is not to outlaw engines; it is to randomize and de-correlate: require engines above a scale to include stochastic offsets and to document independence of input signals from rivals' outputs. The goal is not chaos; it is to break the metronome.

XI. The Wage Mirror

An irony of the profit-price channel is its rhetorical cloak: many price hikes are explained as defenses of wage inflation. Sometimes this is true; often it is exculpatory theater. The test is simple arithmetic: if unit labor cost rose X% but operating margin rose Y% > X, the corridor is doing markup work. No opprobrium is needed; only a rule that such arithmetic be disclosed rather than implied.

This matters because household anger is often misdirected—toward labor itself—when the channel has quietly enlarged $\mu$. A polity that confuses wage defense with margin expansion will pursue policies that shrink paychecks and leave spreads intact.

The IMF noted: if wages later claw back purchasing power, profit shares must compress for inflation to return to target. That compression is precisely what the profit-price channel resists through its five mechanisms.

XII. What This Is Not

XIII. The American–Iberian–Latin American Thread

History ties these regions by law and habit. Spain's regulatory agility during the energy shock—the "Iberian exception"—mirrored a tradition of administrative pragmatism in crisis: decouple, buffer, sunset. In the U.S., we rely more on system-wide levers (monetary policy) and post-hoc antitrust, slower to target bottlenecks in real time. Latin America, long practiced in food price politics, demonstrates both the perils of dominance (corn flour, supermarket cartels) and the promise of concertation (PACIC's negotiated baskets). None of these are ideological. They are engineering choices about how quickly prices return to fundamentals once ships sail, pipelines refill, and harvests arrive.

The shared lesson is modest and operational: when costs fall, prices must meet them. Markets can do this swiftly where rivalry is strong; where they are not, the state's job is to lower the fence—by exposing margins to sunlight, by breaking pass-through bottlenecks, and by refusing code-mediated tacit coordination.

XIV. The Minimal Program

To make this concrete:

  1. Price Decomposition Receipts for large sellers, permanent in emergencies, annual in calm.
  2. Contract Reforms: MFN limits, captaincy firebreaks, surcharge sunsets.
  3. Platform Duties: alternative billing, neutrality audits, identity portability.
  4. Capacity Insurance in chokepoint sectors to dull scarcity before it learns to sing.
  5. Markup Weather Map maintained by a statistical office, published quarterly with sector cuts.
  6. Algorithmic Guardrails: auditable logs; bar ingestion of rivals' non-public data; stochastic offsets.
  7. Cross-border Learning: institutionalize exchange between U.S. antitrust, Spain's CNMC/Bank of Spain, and Latin American authorities (COFECE, FNE, CADE) so that staple market experience feeds back into advanced-economy policy.

Call it bureaucracy if you like; it is better than sermons.

XV. A Short Field Guide for Practitioners

XVI. Epilogue: The Two Labels

Return to the room without windows. On a jar of something ordinary—oil, or coffee, or code—two labels sit as before: what we pay, what it cost. Between them a narrow strip of paper reads markup. If you peel it carefully, you find, underneath, the signatures of a dozen instruments: a platform's toll, a clause forbidding discounts elsewhere, a surcharge that forgot to end, a debt ratio that demanded appeasement, a model that liked the new number, and, sometimes, an engineer who truly made something better.

The point of the peel is not to shame the signers but to name them. Prices will still climb in storms; some spreads will still be earned. But when calm returns, and we examine the jar, we should see whether the third label is still needed. If it is, let it be because of craft. If not, let us remove it, and teach the corridor to prefer transparency to habit.

The profit-price channel is not an accusation. It is a map. Maps do not tell us where to go. They tell us where we are and which doors we have mistaken for walls.

References

Selected sources:

(All legal and economic developments current to November 7, 2025.)

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