Can a plug-in hybrid compete on price?

Sure.

But aren't vehicles like the Volt expected to sell for $40,000 due to a very expensive battery?

Well, first, we should be clear that most of that $40K is not due to the battery.

First, a simple EV, without a battery, should sell for less than a comparable Internal Combustion Engine (ICE) vehicle. Electric motors don't cost any more than ICEs, and EV powertrains are simpler than ICE powertrains (no transmission, muffler, catalytic converter, fuel pump, air filter, oil filter, etc, etc). There are basic sedans out there priced for $15K, so a basic EV should be less than $15K.

Second, GM says the ICE backup on the Volt costs about $2k, and their battery supplier says the battery cells cost right now about $5,600 ($350 per KWH x 16 KWH). There is another $2,400 for the power electronics and battery management system - that's a cost that will mostly go away with very large volume production - so let's allocate 500 for that. 25% markup of those additional pieces ($8,100 x %25) would add about $10,250.

So, the basic pricing should be around $25,000. The rest of the Volt 1st-gen pricing is due to R&D, low-volumes and upper-market options.

You've said battery prices will drop. How do we know?

Here's a good discussion for this (and a lot of other Volt battery information):

"From a historical perspective over the past 17-18 years the cost has come down by a factor of 15x. In the next 5-10 years we should be able to come down by an incremental 2-4x and we will have to do that to accelerate the penetration of the technology."

From http://www.greencarcongress.com/2009/02/profile-li-ion.html