Ebrahim AlhamedFrameworks Library

m.04 · II · Power, Strategy & Rents · Exploiting Market Power

The 1/2 Rule & Cournot

Myatt · a handful of formulas cover most of real-world pricing decisions.

The core idea

When a firm has market power it is a price-maker, not a price-taker. Optimal restriction of output raises margin per unit but loses volume — the profit-maximising balance is surprisingly symmetric for linear demand: produce half the competitive output, at a price halfway between marginal cost and the choke price, capturing half the maximum surplus. Cournot extends the result to N firms. — after Myatt

The hero diagram

Monopoly pricing.

Demand, marginal revenue, marginal cost. The monopolist stops where MR = MC. Consumer surplus shrinks, profit is captured, deadweight loss appears.

Monopoly pricing Demand, marginal revenue (MR), and marginal cost (MC) curves showing monopoly profit, consumer surplus, and deadweight loss compared to competitive equilibrium. D MR MC Pₘ P_c = MC Qₘ Q_c CS profit DWL quantity price

Mechanisms worth naming

The levers in the machine.

Monopoly Rules of Thumb · Myatt
Q* = Q_max / 2 · P* = (P_max + MC) / 2 · Profit = S_max / 2 · DWL = S_max / 4
For linear demand, the optimum is symmetric. Half the quantity, half the surplus.
Markup Rule · Myatt
(P − MC) / P = 1 / |E|
Less elastic demand = higher markup. Always.
Cournot Oligopoly · Myatt
Q_i = Q_max / (N+1) · per-firm profit = (P_max − MC) × Q_max / (N+1)²
As N grows, price → MC and profits → 0.
Asymmetric Cournot · Myatt
lower cost → larger margin → bigger share
Cost advantages compound: market share ∝ profit margin.

How to apply

Setting a price with market power.

  1. Estimate the choke price. Above what price would demand hit zero?
  2. Apply the midpoint rule. Price halfway between MC and choke price. Quantity half of Q_max.
  3. Test elasticity at that point. If demand is more elastic than you thought, the markup shrinks.
  4. Watch for entry. Profits attract rivals. Factor in your Cournot N.

Key reading · Some Simple Rules of Thumb for Exploiting Market Power · Myatt

Optimal output balances volume and margin.

The half-quantity / midpoint-price rule is not always exactly right — demand curves are rarely perfectly linear — but it is almost always more right than intuition. Use it as a sanity check on any pricing decision.

Half the quantity. Halfway the price. Watch the surplus split.

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