Conditions and Consequences of a Price War.

1402 Words Nov 17th, 2007 6 Pages
The objective of this essay is to "use economic theory and illustrative examples to outline the circumstances under which a price war could come about and the likely consequences for the participating firms and their consumers". A price war is a period in which multiple firms competing within the same market will react to the other firms lowering of price by lowering their own price. They have short-term and long-term advantages and disadvantages.

There are many reasons for which a price war may occur, in all cases the reason for starting the price war is different but the reason for its continuation is not to lose sales. They are when a firm attempts to maximise capacity, for survival purposes, in oligopoly markets, where there are
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These services are things such as warranties, loyalty cards and other 'extras'.

The short-run effects upon the firms in the market are negative. Firm's profits are reduced as the price of the good is reduced (see appendix item D). All firms in the industry will be forced to improve their productive efficiency to reduce total average cost, in an attempt to retain profit-margins whilst prices fall. They may also wish to attempt a heavier marketing campaign to try to distinguish itself from the other firms, but this incurs further costs for the firm. Firms are also likely to undergo a faster pace of invention and innovation as they differentiate themselves. Some firm's in the market will be able to use their economies of scale to combat lower prices. But, other firms will not have such efficiencies and will not be able to afford variable costs and will therefore exit the market immediately (see appendix item E).

The long-run affects of a price war are that a lot of firms will leave the market, this causes the demand curve to move back to its original position, which increases market-clearing price creating a long-run equilibrium and so normal profits are re-established. This is a negative aspect to the consumer's who will have to pay more than they have in recent periods, they are also more likely to try and shop round to find the best deal. The good itself is likely to
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