Patrick's PC Shop reported sales of $100,000 last year. Its cost of goods sold was $75,000, which meant gross profits of $25,000.
Now, assume Patrick's PC Shop sells exactly the same number of units this year, but— because of inflation of 5 percent—raised its prices 5 percent. Also assume that its cost of goods rose 5 percent, but that half of its sales will be made from "old" inventory purchased last year, at last year's cost.
So, for the current year, Patrick's PC Shop reports sales of $105,000 and cost of goods sold of $76,875 ($75,000 + 5% [ 1/2 x $75,000]). Patrick's gross profits rose by $1,875—at least some of which will show up in net income—even though its level of business activity remained unchanged.