I opened a business in May, it is doing fairly well. Given the economy and the fact that it is a new business. WELL, a competitor from the other side of town, decided to open a store just down the street from me. His store is bigger (not necessarily nicer), giving him the ability to stock more items (it is a bit crammed where I'm at, but I have nice stock and people love looking through the goodies). I know that this business needs room to grow. I have two options, price war with competitor and try to put him out, or go to him and offer him my business. The problem: I do not know how to approach him and how to present it. Any thoughts?

If you just opened in May, and the competitor is even newer, neither of your businesses have any value beyond inventory and equipment. Use the failing economy to your advantage. Bigger stores come with bigger overheads, that gives you an edge. I wouldn't recommend a price war unless you have deep pockets, it'll probably hurt you more than it helps. It'll cut into your margins making it tougher for you to pay your bills. Offer a loss-leader occasionally to bring in traffic but to lower your prices to drive him out, probably won't work. Continue to work your businessplan and stay the course, and don't borrow...that only diminishes your margins.
Good luck