A Level Economics AQA Practice Exam

What defines a price war?

1. Competitors increasing prices to gain market share

2. Successive price cuts by competitors

3. The establishment of a price floor in a market

4. The collaboration of firms to fix prices

The correct answer is: Successive price cuts by competitors

A price war is characterized by successive price cuts initiated by competitors in an attempt to gain a larger share of the market. This behavior often leads to a downward spiral as each company lowers its prices to attract customers away from rivals, ultimately impacting profit margins for all involved. In the context of market dynamics, a price war typically arises in highly competitive environments where businesses are vying for the same consumer base, leading to aggressive pricing strategies. The nature of this competition tends to stimulate short-term sales boosts but can also have long-term implications for market stability and pricing policies among the firms involved. The other choices describe different market behaviors that do not accurately define a price war. For example, increasing prices to gain market share signifies a different strategy where firms may seek to enhance their profit margins rather than engage in aggressive competition. Establishing a price floor is related to government intervention to prevent prices from falling too low, while collaboration to fix prices suggests collusion, which is illegal and distinctly separate from the concept of a price war.