Price wars, predatory pricing below a rival’s average variable cost, limit pricing, and why oligopolists often compete on everything but price.
In March 2025 Asda’s chairman, Allan Leighton, said Asda would cut prices to restore a 5% to 10% price gap with its rivals, and warned that this would materially reduce its profits. Within a week, Tesco, Sainsbury’s and M&S lost around £3.5bn of share value between them. Tesco leaned on its Clubcard prices and Aldi price match, and set out about £500m of cost cuts to keep its prices competitive.
By the 12 weeks to 25 January 2026, Asda’s share of grocery sales had fallen to 11.5%, from 12.3% a year earlier, and Which? found Tesco cheaper than Asda for the first time in a year.
Why did a price cut leave Asda with a smaller share, not a bigger one? And if price wars hurt everyone, why do firms start them?
Sources: Grocery Gazette and Retail Gazette (March 2025); The Grocer (April 2025); Worldpanel and Which?, reported by Eastern Eye (January 2026).
Everything in this lesson follows from interdependence: with a few large firms, one firm’s price change hits its rivals’ sales, so they react. The kinked demand curve says rivals match a price cut; game theory says each firm is tempted to cut anyway.
So oligopolists have four broad choices:
The alternative to competing at all is to collude, which is the next lesson.
To see how a price war can push a rival out, you need one more idea: the shutdown point.
In March 2025 Asda promised its biggest price cuts in years.
Within days, investors wiped billions off the shares of Tesco, Sainsbury’s and M&S, before any of them had cut a single price.
Why would a rival’s price cuts hit Tesco’s value straight away?
In an oligopoly firms are interdependent. Investors expected Tesco and the others to match Asda rather than lose customers, so every grocer’s profit margin would be squeezed. That is the danger of a price war.
These are the cost curves of a smaller rival firm. As well as ATC, draw AVC, average variable cost. The gap between ATC and AVC is average fixed cost, which shrinks as output rises, so the two curves get closer. MC cuts both AVC and ATC at their lowest points.
The smaller rival follows the market price set by the big firms, so treat each price line as its MR too. At a price of P1, it produces where MC = MR = P1, at q1. Price is above ATC, so it makes abnormal profit.
Now a price war drives the price down to P2. It is below ATC, so the firm makes a loss. But it is above AVC: every unit sold covers its variable cost and contributes something towards fixed costs, which have to be paid anyway. So in the short run it keeps producing.
Check: At P2, price is below ATC but above AVC. In the short run, what should the firm do?
Fixed costs must be paid whether it produces or not. By producing, it covers all its variable costs and puts something towards the fixed costs, so it loses less than if it shut down.
The shutdown point is the lowest point of AVC, where MC meets it. If the price falls below this, the firm does not even cover its variable costs. Every unit adds to its losses, so it is better to stop producing straight away.
Teacher tip: Shutdown is decided by AVC; break-even by ATC. Mixing the two up is the most common mistake on this diagram.
A dominant firm with deep pockets can use the shutdown point against a smaller rival.
Check: To make this rival shut down straight away, how low must the dominant firm push the price?
Only below the lowest point of AVC does each unit add to the rival’s losses, so it is better off stopping at once.
That is what predatory pricing aims for. A dominant firm with deep pockets sets a price like P3, below the rival’s lowest AVC. The rival shuts down and leaves. Once it has gone, the predator raises its price again and earns back its losses.
Limit pricing is different. The incumbent keeps its price below a new firm’s average cost but above its own, so it never makes a loss, and entry simply does not pay. Predatory pricing accepts a loss now to remove a rival already in the market.
Check: What is the difference between predatory pricing and limit pricing?
Predatory pricing targets a rival already in the market, usually with a temporary loss. Limit pricing keeps price just low enough to deter entry, while the incumbent still covers its own costs.
Because price cuts are matched so quickly, oligopolists often prefer non-price competition: advertising and branding, loyalty schemes such as Clubcard and Nectar prices, own-label ranges, store refits, delivery and service. These are harder to copy overnight, and they build brand loyalty, which makes demand less price elastic. They cost money, so abnormal profit, like the box at P1, is what pays for them.
Now apply the models to Asda’s price cut from the start of the lesson.
Check: Asda’s rivals matched its price cuts. What does the kinked demand model say about the demand Asda faced for its cut?
When rivals match a cut, few customers switch, so demand below the current price is inelastic. A lower price on inelastic demand brings in less revenue.
Back to Asda. Its rivals answered with Clubcard prices and price matching, so Asda gained little, and lost profit and market share. That is the kinked demand curve and game theory in action: price cuts are matched, and everyone ends up with lower margins.
They marked the lowest point of ATC. That is where the firm breaks even. The short-run shutdown point is the lowest point of AVC: between the two, the firm makes a loss but should keep producing.
Explain why firms in an oligopoly often prefer non-price competition to price competition.
Firms in an oligopoly are interdependent: a price cut by one firm takes customers from its rivals, so they are likely to respond.
According to the kinked demand model, rivals match a price cut, so the firm that cuts first gains few extra customers. If every firm cuts, the result is a price war: prices and profit margins fall across the market and no firm gains much market share. When Asda cut prices in 2025, Tesco answered with Clubcard prices and price matching, and Asda’s market share still fell.
Non-price competition avoids this. Advertising, branding, loyalty schemes, product quality and service are harder for rivals to copy overnight. They build brand loyalty, which makes demand less price elastic, so the firm can keep its price and margins. These strategies cost money, but abnormal profit can pay for them.
**Evaluation:** price competition still happens when a firm has much lower costs than its rivals, when the market is saturated so growth can only come from rivals’ share, or when a firm wants to win back share quickly, and consumers benefit from it in the short run.
Asda and supermarket figures: Grocery Gazette and Retail Gazette (March 2025), The Grocer (April 2025), Worldpanel via Eastern Eye (January 2026). Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.