Although price wars are expected to be damaging for the firms involved, they do break out from time to time
This may occur when firms wish to increase their market shares, or when existing firms wish to deter the entry of new firms into the market.
Predatory pricing is an extreme strategy that forces all firms to endure losses. It is normally invoked in an attempt to eliminate a competitor, and is illegal in many countries.
Limit pricing occurs when a firm or firms set a price below the profit maximising level in order to prevent entry. The limit price is the highest price that an existing firm can set without allowing entry
In some cases the limit price may enable to incumbent firm to make only normal profit. Such a market is said to be contestable
Contestibility requires that there are no barriers to entry or exit and no sunk costs – and that the incumbent firms have no cost advantage over hit and run entrants
Firms have adopted other strategies designed to deter entry, such as using advertising or R&D spending to raise the cost of entry by adding to the required fixed costs