Business Ethics: Concepts & Cases (6th edition) : Chapter 4
Ethics in the Marketplace

Introduction

• If free markets are moral it's because they allocate resources & distribute commodities
1. in ways that are just
2. that maximize economic utility
3. that respect the liberty of both buyers and sellers
• These three benefits depend crucially on competition
• .Consequently, anticompetitive practices are morally dubious
• Two kinds of anticompetitive conditions and practices
• monopoly conditions: a market segment controlled by one seller
• oligopoly conditions: a market segment controlled by a few sellers

4.1 Perfect Competition

• Under perfect competition, "no buyer or seller has the power to significantly affect the prices at which goods are exchanged."
• Seven features of perfectly competitive markets:
1. distributed: numerous buyers & sellers, none of whom has a substantial market share
2. open: buyers and sellers are free to enter or leave the market
3. full and perfect knowledge: each buyer & seller has full and perfect knowledge of each others' doings
4. equivalent goods: goods being sold are similar enough that buyers don't care whose they buy.
5. unsubsidized: costs of producing or using goods is borne entirely by the buyers & sellers
6. rational economic agency: all buyers and sellers act as egoistic utility maximizers
• try to buy (or produce) as low as possible
• sell as high as possible
7. unregulated: no external parties such as governments regulate the price, quantity, or quality of goods
• Breakdown of the seven features
• 1-2 -- openness and distribution -- the "basic conditions"
• 3-6 are "idealizing conditions"
• 7 -- nonregulation -- a measure of how free the market
• all real economies are mixed, mixing
• free market elements
• command elements
• regulative admixtures justified by appeal to
• social utility
• distributive justice
• rights -- especially positive or welfare rights
• Essential presuppositions
• an enforceable private property system so buyers and sellers have ownership rights to exchange
• a system of contracts to facilitate & control transfers of ownership
• an underlying system of production so there's goods to be exchanged
• Self-regulation: the basis for the alleged moral benefits of competitive markets
• supply > demand
• sellers bid prices down: assumes distribution among sellers
• falling profits lead to decreased production: assumes openness
• profits in one market sector falling below those in others
• causes sellers to move into the other, more profitable, sector
• demand > supply
• buyers bid prices up: assumes distribution among buyers
• rising profits lead to increased production: assumes openness
• profits in one market sector rising above those in others
• causes sellers to move out of the others and into the more profitable sector

Equilibrium in Perfectly Competitive Markets

• Principle of Diminishing Marginal Utility
• affecting demand
• states that each additional item consumed
• is less useful or satisfying than each of the earlier items
• consequently is less valuable than each of the earlier items
• consequence: "the price consumers are willing to pay for goods diminishes as the quantity of goods they buy increases"
• Principle of Increasing Marginal Costs
• affecting supply
• states that each additional item produced after a certain point costs more to produce than earlier items
• point determined by countervailing economies of scale & scarcity or plenitude of resources
• costs breakdown = ordinary costs + normal profits
• "ordinary" costs of production & distribution
• costs of labor
• materials
• marketing
• distribution
• etc.
• "normal" profit: "the average profit the producers could make in other markets that carry similar risks" (p. 213)
• Equilibrium price: the price at which supply = demand, i.e.,
• the amount buyers will pay for a quantity of goods
• the production costs (including normal profits) of that quantity for the sellers
• Discussion: Perfect Competition as useful idealization
• only a few markets -- mainly agricultural commodities markets -- come close to the ideal
• perfect competition and explanatory construct or idealization
• enables economists to make predictions as with other useful idealizations
• use of equations governing "frictionless planes" to estimate behavior of real inclined planes
• use of equations governing "free fall in a vacuum" to estimate the behavior of bodies falling in the atmosphere
• etc.
• ethically illuminating
• provides us with a clear understanding of the advantages of competition
• and understanding of why it may be desirable to keep markets as competitive as possible

Ethics and Perfectly Competitive Markets (PCMs)

• Capitalist distributive justice is well served by perfectly competitive markets
• contributive justice: to each according to their contribution
• counting capital or ownership of the means of production as a contribution
• counting the value of workers contribution as = the price their services command on the job market
• accords with the practice of counting "normal" profit as a cost of production
• Economic utility or efficiency is best served
• demand is served: sellers sell and producers produce what consumers want
• efficiency is forced on producers & distributors by competition
• consumers individual preferences are served
• each gets what they in particular most want
• from among the goods available
• Negative rights are well respected, especially rights of economic liberty
• to buy and sell whatever you choose
• whenever you choose
• to and from whomever you choose
• Limitations on Perfectly Competitive Markets' Claims to Moral Superiority
• Justice under competing conceptions not so well served
• egalitarian justice violated by income & wealth disparities arising under PCMs
• distribution according to ability to pay vs. need is contrary to needs-based conceptions
• counting the value of labor as the price it commands on the job market contrary to Marxian contribution-based justice
• value of labor = fair-market value of product minus the ordinary costs of production
• "normal" profit not counted as a cost of production
• Justice and benefits alleged accrue only to market participants or those with money to buy
• it's only their demand that are served
• it's only their individual preferences that are served
• Positive rights of the poor may be violated: e.g., rights to
• food & shelter
• education
• health-care
• Conditions for perfect competition may conflict with care
• rational egoistic utility maximization neglects caring -- it's selfish
• efficiency demands of competition may conflict with caring
• if I'm too caring
• pay my help substantially more than my competitors
• if I spend substantially more on pollution controls than my competitors
• if I spend spend substantially more on safe working conditions than my competitors
• then I may lose out in the competition
• my production costs will be higher
• my competitors will undersell me
• putting me out of business
• Certain bad character traits may be encouraged and certain good traits discouraged by competitive markets
• discouraged good traits
• kindness
• caring
• generosity
• negative traits encourages
• greed & self-seeking
• materialism
• Imperfections of real markets
• insofar as they fall short of perfect competitiveness
• they may fail to deliver even the promised benefits of
• serving capitalistic justice
• maximizing utility
• securing negative rights of economic liberty

4.2 Monopoly Competition

• In monopoly conditions the first two of the seven conditions defining perfect competition are violated
• not distributed but concentrated
• instead of "numerous sellers, none of whom has a substantial share of the market"
• one seller has a 100% share of the market
• not open but closed
• instead of other sellers being able to "freely and immediately enter"
• other sellers are prevented from entering due to various factors
• patent laws
• high capitalization costs
• anticompetitive machinations of the monopoly holder
• etc.
• Monopoly markets
• Definition: "markets . . . in which a single firm is the only seller in the market and which new sellers are barred from entering." (p. 221)
• Principal Market-Distorting Effect
• inability of other competitors to enter the market
• thereby increasing supplies
• thereby bidding prices down
• results in artificially high prices
• above the "natural price" or equilibrium point
• natural price = cost of production + going-rate-of-profit (CP + GRP)

Monopoly Competition: Justice, Utility, and Rights

• Monopoly Markets & Capitalist Justice
• Capitalist justice says: "to each according to their contribution of labor or investment.
• Equilibrium point is where Capitalist justice is served.
• Under monopoly conditions prices kept above equilibrium
• so the seller charges more than the goods are worth (i.e., their natural price)
• so the prices the buyer is forced to pay are unjust (i.e. > CP +GRP)
• Monopoly Markets & Economic Utility
1. Monopolies foster distributive inefficiency: demand is not served
• monopolies create (virtual?) shortages (indicated by high profits)
• other firms unable to enter the market to make up these shortages
• excess profits absorbed by the seller are resources not needed to supply the amounts of goods the consumers are getting:
• if others were free to enter the market
• the same goods would be supplied for less.
2. Monopolies remove competitive pressures making for productive efficiency
3. Discretionary preferences of consumers not as well-served:
• consumers forced cut back more than they would have had to (under "normal" conditions)
• to buy the monopolized goods
• Monopoly Markets and Negative Rights of Economic Freedom
• Sellers not free to enter.
• Buyers buy under duress: monopoly sellers can dictate terms to buyers
• goods they may not want:
• "You have to buy the Service Agreement with that."
• Example: Microsoft marketing of Explorer
• quantities they may not desire: "sorry it only comes by the dozen."
• GM's reply to Bill Gates (humor)

4.3 Oligopolistic Competition

• True monopolies are rare: but a second type of "imperfectly competitive market" is common.
• Oligopoly conditions: a few firms control most of the market
• relatively common ("business as usual")
• have similar dynamics and anticompetitive effects
• In oligopoly conditions the first two of the seven conditions defining perfect competition are violated
• not distributed but concentrated
• instead of "numerous sellers, none of whom has a substantial share of the market"
• a few sellers have a near 100% share of the market
• not open but closed
• instead of others sellers being able to "freely and immediately enter"
• other sellers are prevented from entering due to
• high start-up costs
• anticompetitive machinations of the oligopoly firms
• long-term contracts with buyers
• etc.
• Concentration
• the fewer the firms controlling the market the more "highly concentrated" the market
• the more firms controlling the market the less "highly concentrated"
• Horizontal mergers: the chief cause of oligopolistic conditions
• horizontal merger =
• "unification of two or more companies that were formerly competing in the same line of business"
• e.g., Daimler, Disney-Times-Warner
• anticompetitive Dynamic: Creation of Virtual Monopoly Conditions via Collusion
• with only a few firms in the market it is relatively easy for them to join forces and act as a unit "much like a single giant firm"
• by agreeing to set prices at the same (excessively high) level
• tacitly: a "gentlemen's agreement"
• explicitly: price fixing
• by agreeing to restrict output & control supply (OPEC)
• with similar anti-competitive & consequently dubious ethical consequences
• violations of capitalist justice
• negative impacts on economic utility
• distributive inefficiencies
• productive inefficiencies
• diminished discretionary preference satisfaction
• with similar negative (economic freedom) rights violations
• others are prevented from entering the market
• sellers dictate terms
• buyers have no recourse
• since the "competition" has agreed to dictate the same terms

Explicit Agreements

• Price fixing: managers meet (secretly) & agree to set prices at a artificially high levels.
• Manipulation of Supply: firms agree to limit their production
• result in artificially induced shortages
• hence in artificially high prices
• Exclusive Dealing Arrangements: firms sell to retailers on condition
• that retailers will not buy from certain other companies (contra openness)
• or will not sell outside of a certain geographical area (contra distribution)
• Tying Arrangements: the seller agrees to sell to buyer only on condition that the buyer agrees to buy other products from the firm.
• Retail Price Maintenance Agreements: manufacturer sells to retailer only on the condition
• that they agree to charge the same set retail price for the goods.
• effects
• diminishes competition between retailers
• removes competitive pressure on the manufacturer to
• lower prices
• decrease production costs
• Price Discrimination: charging different prices to different buyers for identical goods.
• Examples
• Continental Pie Co. underselling Utah Pie Co. in Salt Lake City
• Most famous case: Standard Oil cornering of the oil market at the end of the 19th century
• used regional price discrimination region by region
• to undersell the locally based oil companies & drive them out of business.
• The airlines?
• Price differences are legitimate only when based on
• volume differences
• other differences related to true costs of
• manufacturing
• transporting
• packaging
• marketing
• servicing

Tacit Agreements

• Explicit agreements to undertake many of the anti-competitive practices just named are illegal
• Most collusion between oligopolies, consequently is based on unspoken or "tacit" forms of cooperation
• Genesis of unspoken cooperation
• firms each come to recognize that competition is not in their best interest
• that cooperation would be in the best interests of all
• so without any explicit agreement to cooperate
• they undertake to act as if there were such an agreement
• you might say there is such an agreement de facto or in practice
• Price-setting: when one major player raises prices, all the would-be competitors follow suit
• each realizes all will benefit as long as they continue to act in this concerted fashion
• "price leader" version
• the oligopolies recognize one (dominant) player as the industry's price leader
• and tacitly agree to follow suit in setting prices at whatever level this firm sets

Bribery

• Bribes can be used to secure the sale of products
• serve to shut out other sellers
• hence, are anticompetitive
• Not all bribes are of this sort: e.g. "tips" customarily given to customs agents in some countries to "expedite the process"
• Ethical rules for bribery: potentially excusatory & mitigating questions
• Is the offer of payment initiated by the payer?
• if so, this is a morally culpable act of bribery
• if not -- if the payee initiates the transaction by demanding payment (usually accompanied by an explicit or implicit threat: e.g., the processing won't be "expedited")
• it's more like extortion by the payee than bribery by the payer
• the payer is absolved of moral responsibility or their responsibility is at least diminished
• Is the payment made to induce the payee to act in a manner contrary to the duties or responsibilities of their office
• if so: it's a morally culpable bribe: the payer is inducing the payee to act immorally
• if not -- as in the case of the customs official -- it may not be.
• Are the nature and purpose of the payment considered ethically unobjectionable by the local culture
• if so (again as in the case of the customs agent)
• then it may be morally excusable
• if not done for anticompetitive purposes
• if not done for the purpose of inducing the payee to do something immoral
• may be ethically permissible on utilitarian grounds: otherwise the process won't be "expedited"
• might, however, still be a legal violation of the Foreign Corrupt Practices Act of 1977
• agreement with local practices won't be a mitigating or excusing factor
• if it is done for anticompetitive purposes
• or if it is done for the purpose of inducing the payee to do something immoral

Oligopolies and Public Policy

• The problem
• Competition within industries has declined & is declining.
• What to do in light of this fact?

The Do-Nothing View

• No Problem:
• Competition between industries with substitutable products takes the place of competition within
• example: steel industry, though highly concentrated, faces competition from plastics, aluminum, etc.
• question: what to do when Alcoa & U. S. Steel & 3M merge?
• "Countervailing power" of other large corporate groups blunts the effects of concentration
• unions & government
• large corporate buyers not so easy to dictate terms to
• Chicago School: markets are economically efficient with as few as three significant rivals
• Big is good
• economies of scale
• reductions in unit costs of production
• using the same fixed resources
• offsets drawbacks:
• excessive profits
• offset by incredible cost savings
• necessary to meet foreign competition from subsidized industries
• Velasquez is dubious: "research suggests that
• in most industries expansion beyond a certain point
• will not lower costs but will instead increase them."

The Antitrust View

• Reinstitution of competitive pressures
• is necessary in order to rein in excessive oligopoly profits
• requires breaking up large firms into smaller units (each controlling not more than 3-5% of the market)
• Expected results
• higher levels of competition will emerge
• along with a decrease in explicit and tacit collusion
• bringing about the beneficial consequences
• lower prices for consumers
• greater innovation
• increased development of cost cutting technologies

The Regulation View

• Oligopoly corporations should not be broken up
• economies of scale would be lost if they were forced to decentralize
• mass production
• mass distribution
• etc.
• these economies should be passed on to consumers in the form of
• cheaper products
• more plentiful products
• To pass savings due to economies of scale along to consumers requires proper regulation of large corporations
• nationalization -- government take-over of operations
• the regulative extreme
• controversial
• sometimes necessary & beneficial, some argue
• never necessary or beneficial others argue
• leads to unresponsive bureaucracy
• removes competitive pressure from these firms or industries which negatively effects
• productivity
• efficiency
• innovation
• proponent of regulation usually have in mind measures less extreme than regulation
• to ensure that markets continue to be structured competitively:
• to ensure that firms maintain competitive market relations between themselves
• i.e., to prevent collusion
• may be voluntarily followed or legally enforced
• justified insofar as competition is necessary to best secure
• utilitarian benefits
• distributive justice
• rights to negative freedom

Case for Discussions

Playing Monopoly: Microsoft (ABC News CD-ROM)

Case History

• 1977: Bill Gates & Paul Allen begin writing programs for the Apple II PC, rename their company Microsoft, and move to Seattle "where, with 13 employees, it ended the year with revenues of 1.4 million."
• 1980: IBM belatedly decides to enter the PC market & finds itself in need of an operating system fast
  • CP/M (a multiplatform OS) turns down IBMs offer to license its OS for IBM
  • Approach Bill Gates who says he can provide them with an OS
  • "Gates went to a friend who he knew had written a ... 'knock-off of CP/M' and paid him $60,000 for the rights to this 'knock off': Gates did not tell his "friend" about the IBM offer
  • IBM's share of the market grew to 40% by 1987.
• "MS-DOS became the standard operating system for computers built to IBM standards," roughly 90% of all PCs
  • thousands of applications including Microsoft's own MS Word and Mulitplan developed for this OS
• 1984: Apple Computer develops operating system with graphical interface
• 1987: Microsoft releases its Windows OS also featuring graphical interface
  • Apple sued Microsoft for infringement: claiming that because Windows copied the "look and feel" of the their copyrighted MacIntosh OS
  • Apple lost the case and with it the competitive advantage it had briefly enjoyed"
  • Microsoft continues to control some 90 percent of the personal computer market
• Netscape
  • Netscape Navigator after its release in December of 1994 Navigator quickly captured 70% of the internet browser market
  • browsers do not only display text and graphics but can execute instructions (software programs) much like an OS, making them a potential competitors to Windows.
• Bill Gates' 1995 memo: "A new competitor "born" on the internet is Netscape.  Their browser is dominant, with a 70% usage share.  They are pursuing a multi-platform strategy where they move the key API [applications programming interface] into the client to commoditize the underlying operating system."
• Java
  • a programming language developed by Sun Microsystems in 1995
  • can operate on any computer equipped with Java software regardless of the OS, again threatening to make Windows obsolete
  • "This scares the hell out of me," Bill Gates wrote in an internal e-mail.
• Navigator + Java! Oh no!
  • Netscape agreed with Sun to incorporate Java into Navigator
  • So Java programs didn't need Windows: they could run on any Navigator equipped computer
  • Furthermore, this made Navigator a "major distribution vehicle" for Java
• Microsoft kills Navigator
  • Microsoft's "offer you can't refuse"
    • Offer: Microsoft would supply the browser for the Windows operating system and Netscape would provide browsers only for other operating systems.
    • Since this would be to exchange 70% market share for a 10% market share, Netscape naturally refused
    • Microsoft punished Netscape for this by refusing to share the codes for Windows 95 to impede Netscape from developing a new version of their browser to take advantage of the Windows 95 API
  • Microsoft's Internet Explorer
    • competing browser released in 1995
    • failed to make the major inroads in Netscape's market share that Microsoft wanted
    • Microsoft executive Christian Wildfeuer wrote in a 1997 memo that it would be "very hard to increase browser share on the merits of Internet Explorer 4 alone" and proposed that Microsoft "leverage our Operating System asset to make people use Internet Explorer instead of Netscape Navigator."
  • Implementation of the bundling strategy
    • Window 95: incorporated a copy of Internet Explorer that automatically installed with the OS
    • Windows 98: fully integrated Internet Explorer with the OS so that IE couldn't really be removed: Windows 98 called on IE to perform crucial operations despite the fact that
      • this slowed its operations
      • made it more crash prone
      • made it difficult and risky for PC owners to try to replace IE with Navigator as their default browsers
      • undercut Netscape on pricing by giving away IE "for free," as Microsoft put it
      • Microsoft further required computer manufacturers to agree not to promote Netscape's browser [by making it the default browser] and offered incentives to manufacturers not to install Navigator at all.
    • Success!  Navigator's market share plummeted and Explorer's soared.
• Microsoft "pollutes" Java
  • Microsoft negotiates a license to distribute Java with Windows from Sun
    • Sun "not knowing that Microsoft was planning to change Java" (Velasquez)
    • [Or were threats employed, as with Netscape.  Perhaps MS made Sun "an offer they couldn't refuse".]
  • Microsoft distributes an altered version incorporating changes that prevent regular (Sun) Java programs from running on computers using MS-Java.
  • Since 90% of machines are now MS, applications programs began to be written for MS Java & not Sun.
  • The "strategic objective" to "kill cross-platform Java" by expanding the "polluted Java market" (as and internal MS document puts it), had been achieved: "Microsoft had turned Java into a part of Windows" (Velasquez)
• U.S. DOJ (under Janet Reno in 1998) accuses Microsoft of "a pattern of anticompetitive practices designed to thwart browser competition on the merits, to deprive customers of choice between alternative browsers, and to exclude Microsoft's Internet browser competitors" that was in violation of the Sherman Antitrust Act, the DOJ charged, on four counts.
  • Judge Jackson finds Microsoft guilty on three of the counts
  • Ordered MS to be broken up into two separate companies
    • MS OS marketing & development
    • MS applications program marketing & development
  • Furthermore ordered
    • MS could not punish or threaten computer manufacturers for installing and promoting competitors' products
    • MS had to allow computer manufacturers to remove any MS applications from the Windows OS [i.e., unbundle the aps.]
    • that MS would not have to implement his orders until it had time to appeal
• Ruling on Appeal
  • Jackson's findings of fact were accepted
  • Jackson's breakup penalty was reversed: MS argued his bias against Microsoft affected the severity of the remedy he imposed
  • A new penalty would have to be devised.
• New Penalty: Negotiated in 2001 between MS and "the new Republican-appointed head of the DOJ" John Ashcroft
  • MS would share its API with rival applications software companies
  • MS would give computer makers and users the ability to hide icons for Windows applications
  • MS could not prevent competing programs from being installed on Windows computers
  • MS could not retaliate against computer makers that used competing software.
  • however, MS could continue to bundle applications into the OS
• Ongoing Pattern
  • MS tried to corner the server market to share APIs with competing server software programmers
  • MS bundled its Windows Media Player together with Windows 2000
  • 2004 European Commission
    • fined MS $613 million
    • ordered MS to disclose the APIs to competing server software programmers
    • ordered MS to offer a version of Windows without Windows Media Player
  • On appeal: MS doesn't have to offer that version until appeals are exhausted: that will take several years
• Linux -- a free open source OS -- is an emerging alternative to windows

Questions for Discussion

1. Identify the behaviors that you think are ethically questionable in the history of Microsoft.  Evaluate the ethics of these behaviors.
2. What characteristics of the market for operating systems do you think created the monopoly market for Microsoft?  Evaluate this market in terms of utility, rights, and justice.
3. In your view, should the government have sued Microsoft for violation of the antitrust laws?  Was Judge Jackson's order that Microsoft be broken into two companies fair to Microsoft?  Was Judge Kollar-Kotelly's November 1, 2003 decision fair?  Was the April 2004 decision of the European Commission fair to Microsoft?
4. Who, if anyone, is harmed by the sort of market that Microsoft's operating system has enjoyed?  What kind of public policies, if any, should we have to deal with industries like the operating system industry?
5. What other issues do you believe this case raises or what else to you think it shows?

Archer Daniels Midland and the Friendly Competitors

Questions for Discussion

1. Evaluate Terry Wilson's assertion that the difference between the $1.20/lb. price of Lysine when ADM entered the market and the $.60/lb. the price fell to due to the oversupply that resulted from ADM's entry  was money that the five companies were "giving away to their customers" (p.201).  What, if anything, is wrong with the principle that "the competitor is our friend and the customer is our enemy"?  
2. Your text cites a number of factors that cause companies to engage in price-fixing.  Identify the factors that you think were present in the ADM case & explain.
3. Was Mark Whitacre to blame for what he did?  For which of the things that he did?  Do you feel that in the end he was treated fairly?  Why or why not?
4. What other issues do you believe this case raises or what else to you think it shows?