What typically happens during a price war?

During a price war, the competition between firms is characterized by aggressive pricing strategies aimed at gaining market share or driving out competitors. As firms continuously lower their prices to attract customers away from rivals, this leads to a significant decrease in market prices. Consequently, profit margins shrink as the revenue generated per unit sold declines substantially, making it difficult for firms to maintain profitability.

In this context, a price war can create a cycle where each firm attempts to undercut the others, which exacerbates the price decline. The end result typically sees prices falling rapidly and often leading to unsustainable business practices, where some firms may struggle to cover even their costs. This highlights the intense competitive dynamics in markets where price competition is fierce, further explaining why the option regarding prices collapsing and profit margins shrinking is indeed the correct choice.