978-0205017669 Chapter 4 Lecture Note

Unlock access to all the studying documents.

View Full Document

CHAPTER FOUR

Ethics in the Marketplace

Overview

Introduction

This chapter moves the consideration of business ethics from the morality of the economic

system in general to the morality of specific practices within our system. Given that our

system generally follows the free market model, which is based on competition; it may be

surprising to note that there are so many examples of anticompetitive practices in the U.S.

today. A report on New York Stock Exchange companies showed that 10 percent of the

companies had been involved in antitrust suits during the previous five years. A survey of

major corporate executives indicated that 60 percent of those sampled believed that many

businesses engage in price fixing.6 One study found that in a period of two years alone over

sixty major firms were prosecuted by federal agencies for anticompetitive practices.

Actually, it is more than surprising. The morality of the free market system itself is based

crucially on the idea of competition creating a just allocation of resources and maximizing

the utility of society’s members. As we will see, the ethical concepts of utility, justice and

rights are intrinsic features of markets that are perfectly competitive. To the extent that

the market is not competitive, it loses its moral justification for existing.

To understand the nature of market competition and the ethics of anticompetitive practices,

it is helpful to examine three abstract models of the different degrees of competition in a

market: perfect competition, pure monopoly, and oligopoly.

4.1 Perfect Competition

In a perfectly free competitive market, no buyer or seller has the power to significantly

affect the price of a good. Seven features characterize such markets:

1. There are numerous buyers and sellers, none of whom has a substantial share of the

market.

2. All buyers and sellers can freely and immediately enter or leave the market.

3. Every buyer and seller has full and perfect knowledge of what every other buyer and

seller is doing, including knowledge of the prices, quantities, and quality of all goods

being bought and sold.

4. The goods being sold in the market are so similar to each other that no one cares

from whom each buys or sells.

5. The costs and benefits of producing or using the goods being exchanged are borne

entirely by those buying or selling the goods and not by any other external parties.

6. All buyers and sellers are utility maximizers: Each tries to get as much as possible

for as little as possible.

7. No external parties (such as the government) regulate the price, quantity, or quality

of any of the goods being bought and sold in the market.

In addition, free competitive markets require an enforceable private property system and a

system of contracts and production.

In such markets, prices rise when supply falls, inducing greater production. Thus, prices and

quantities move towards the equilibrium point, where the amount produced exactly

equals the amount buyers want to purchase. Thus, perfectly free markets satisfy three of

the moral criteria: justice, utility, and rights. That is, perfectly competitive free markets

achieve a certain kind of justice, they satisfy a certain version of utilitarianism, and they

respect certain kinds of moral rights.

The movement towards the equilibrium point can be explained in terms of two principles:

the principle of diminishing marginal utility and the principle of increasing marginal

costs. When a buyer purchases a good, each additional item of a certain type is less

satisfying than the earlier ones. Therefore, the more goods a consumer purchases, the less

he will be willing to pay for them. On the supply side, the more units of a good a producer

makes, the higher the average costs of making each unit. This is because a producer will

use the most productive resources to make his or her first few goods. After this point, the

producer must turn to less productive resources, which means that his costs will rise. Since

sellers and buyers meet in the same market, their respective supply and demand curves will

meet and cross at the point of equilibrium or equilibrium price.

Though some agricultural markets approximate the model of the perfectly competitive free

market, in actuality there is no real example of such a market. Markets that do not have all

seven features of the perfectly free market are, therefore, correspondingly less moral.

In the capitalist sense of the word, justice is when the benefits and burdens of society are

distributed such that a person receives the value of the contribution he or she makes to an

enterprise. Perfectly competitive free markets embody this sense of justice (in terms of

capitalistic justice), since the equilibrium point is the only point at which both the buyer and

seller receive the just price for a product. Such markets also maximize the utility of buyers

and sellers by leading them to use and distribute goods with maximum efficiency. This is

done in a way that respects the buyers and sellers’ right of free consent.

Efficiency comes about in perfectly competitive free markets in three main ways:

1. They motivate firms to invest resources in industries with a high consumer demand

and move away from industries where demand is low.

2. They encourage firms to minimize the resources they consume to produce a

commodity and to use the most efficient technologies.

3. They distribute bundles of commodities among buyers so that they receive the most

satisfying commodities they can purchase, given what is available to them and the

amount they have to spend.

Finally, perfectly competitive markets establish capitalist justice and maximize utility in a

way that respects buyers’ and seller’ negative rights.

First, in a perfectly competitive market, buyers and sellers are free (by definition) to enter

or leave the market as they choose. That is, individuals are neither forced into nor

prevented from engaging in a certain business, provided they have the expertise and the

financial resources required.

Second, in the perfectly competitive free market, all exchanges are fully voluntary. That is,

participants are not forced to buy or sell anything other than what they freely and knowingly

consent to buy or sell. Third, no single seller or buyer will so dominate the market that he is

able to force the others to accept his terms or go without. In this market, industrial power is

decentralized among numerous firms so that prices and quantities are not dependent on the

whim of one or a few businesses. In short, perfectly competitive free markets embody the

negative right of freedom from coercion. Thus, they are perfectly moral in three important

respects: (a) Each continuously establishes a capitalist form of justice; (b) together they

maximize utility in the form of market efficiency; and (c) each respects certain important

negative rights of buyers and sellers. No single seller or buyer can dominate the market and

force others to accept his terms. Thus, freedom of opportunity, consent, and freedom from

coercion are all preserved under this system.

Several cautions are in order, however, when interpreting these moral features of perfectly

competitive free markets. First, perfectly competitive free markets do not establish other

forms of justice. Because they do not respond to the needs of those outside the market or

those who have little to exchange, for example, they cannot establish a justice based on

needs. Second, competitive markets maximize the utility of those who can participate in the

market given the constraints of each participant’s budget. However, this does not mean that

society’s total utility is necessarily maximized. Third, although free competitive markets

establish certain negative rights for those within the market, they may actually diminish the

positive rights of those outside those whose participation is minimal. Fourth, free

competitive markets ignore and even conflict with the demands of caring. As we have seen,

an ethic of care implies that people exist in a web of interdependent relationships and

should care for those who are closely related to them. A free market system, however,

operates as if individuals are completely independent of each other and takes no account of

the human relationships that may exist among them. Fifth, free competitive markets may

have a pernicious effect on people’s moral character. The competitive pressures that are

present in perfectly competitive markets can lead people to attend constantly to economic

efficiency. Producers are constantly pressured to reduce their costs and increase their profit

margins. Finally, and most important, we should note that the three values of capitalist

justice, utility, and negative rights are produced by free markets only if they embody the

seven conditions that define perfect competition. If one or more of these conditions are not

present in a given real market, then the claim can no longer be made that these three

values are present. This, in fact, is the most crucial limitation of free market morality,

because real markets are not perfectly competitive, and consequently they may not achieve

the three moral values that characterize perfect competition.

4.2 Monopoly Competition

In a monopoly, two of the seven conditions are absent: there is only one seller, and other

sellers cannot enter the market. Two examples are Microsoft’s operating system and office

suite software. As the case of Microsoft exemplifies, such markets are far from the perfectly

competitive model. The operating system market is dominated by Microsoft’s Windows

which had a total global market share of 92 percent in 2010. Microsoft also has a monopoly

in the worldwide market for integrated office suite software where its MS Office suite

commanded 94 percent of the market in 2010. Technically, a company must have 100

percent of the market to be a monopoly. But in practice, a company can do it with lesst.

The key feature that determines whether a company has a monopoly is whether that one

company has such control over a product is whether that one company determines who can

get some of the product and at what price. So, while Microsoft does not hold 100 percent of

either of these markets, most observers characterize its control of these markets as

monopolies.

There are several “barriers to entry” any company that wants to come into these markets

has to overcome. One barrier is sheer total cost and risk: today it costs more than $10

billion to develop a new operating system like Windows and it would be extremely risky for

a company to spend $10 billion on the gamble that it might overcome Microsoft’s dominance

of the market. A second barrier is economies of scale which occur when the amount of

product a company makes has grown so large that it costs it less to make each unit of its

products than it would cost any smaller firm.

Yet another barrier is the so-called “network effect” in which the value of a product

increases as the number of users increases. Consumers prefer Windows over other

operating systems like Unix because there are many more software programs available for

Windows than for Unix. And the reason why there are many more programs for Windows is

because software developers would much rather develop programs for Windows’ many

users, than for Unix’s few users

Unregulated monopoly markets fall short of the three values of capitalistic justice, economic

efficiency, and respect for negative rights that a perfect competition achieves. First,

monopolistic markets enable the seller to charge more than the goods are worth. Thus, the

prices the buyer must pay are unjust because capitalistic justice says that what each person

receives should equal the value of the contribution they made. Second, the monopoly

market results in a decline in the efficiency of the system. There is little incentive for the

monopoly firm to reduce its costs. Third, monopoly markets place restrictions on the

negative right that perfectly free markets respect, (a) monopoly markets are markets that

other sellers are not free to enter and (b) monopoly markets enable the monopoly firm to

force on its buyers goods that they may not want in quantities they may not desire.

A monopoly market is then, is one that can, and generally will, deviate from the ideals of

capitalist justice, economic utility, and negative rights. A monopoly market allows the

monopoly firm to dictate terms to the consumer, replacing the consumer as “sovereign” of

the market.

4.3 Oligopolistic Competition

Most industries are not entirely monopolistic; in fact, most are dominated by a few large

firms. These markets lie somewhere in between the monopoly and the perfectly competitive

free market; the most important type of these imperfectly competitive markets is the

oligopoly.

In an oligopoly, two of the seven conditions are not present. Instead of many sellers, there

are only a few significant ones and the firms controlling this share may range from 2 to 50

firms depending on the industry. Second, as with the monopoly, other sellers are not free to

enter the market. A list of firms in oligopoly markets in the most highly concentrated

American industries reads like a who’s who of American corporate power.

Oligopoly markets that are highly concentrated markets are dominated by a few (three to

eight) large firms. They include many of the largest manufacturing industries.

The most common cause of oligopolistic market structure is the horizontal merger or

unification of two companies that formerly competed in the same line of business. Because

such markets are comprised of a small number of firms, it is easy for their managers to join

forces to set prices and restrict their output, acting, in effect, like one large monopolistic

firm. Therefore, like monopolies, they can fail to set just profits, respect basic economic

freedoms, and protect social utility.

A highly concentrated oligopoly has a relatively small number of firms, making it relatively

easy for mangers of these firms to join forces and act as a single giant firm. They can

operate in much the same way as a monopoly, failing to exhibit fair prices, reducing social

utility and failing to respect economic freedom.

Oligopolies can set high prices through explicit or tacit agreements to restrain competition.

The more highly concentrated the oligopoly, the easier it is to collude against the interests

of society, economic freedom, and justice. The following list identifies practices that are

clearly unethical:

1. Price Fixing – when companies agree to set prices artificially high.

2. Manipulation of Supply – when a company agrees to limit production.

3. Market Allocation – “Market Division” occurs when companies in an oligopoly

divides up the market among themselves (“you get India and I get China”).

4. Bid Rigging – Occurs when managers in an oligopoly market decide in advance

which of them will submit the winning bid.

5. Exclusive Dealing Arrangements – when a company sells to a retailer only on

condition that the retailer will not purchase products from other companies and/or

will not sell outside a certain geographical area.

6. Tying Arrangements – when a company sells a buyer certain goods only on

condition that the buyer also purchases other goods from the firm.

7. Retail Price Maintenance Agreements – when a company sells to a retailer only

on condition that they agree to charge the same set retail prices.

8. Predatory Price Discrimination – Price discrimination is when a company charges

different prices to different buyers for the same goods or services. It becomes

predatory price discrimination when the company’s intent is to run its competitor out

of business.

9. Bribery – Many companies have secretly bribed government officials so they will

purchase goods from the company and not its competitors. When a bribe takes place

the bribing company becomes a monopoly.

Several industrial and organizational factors lead companies to engage in these practices:

Incentives and Pressures

1. A Crowded and Mature Market – Mature industries are sometimes subject to

oversupply because demand begins to fall or companies all increase production at

the same time, or many new companies come into the market. As prices fall and

revenues decline, middle managers can feel pressured to do something to halt their

losses and may respond by allowing, encouraging, and even ordering their sales

teams to engage in price-fixing

2. Undifferentiated Products – When the product offered by each company in an

industry is so similar to those of other companies the companies have no choice but

to compete on price alone. This can lead to periodic price wars and salespeople come

to feel that the only way to keep prices from collapsing is by getting together and

fixing prices.

3. Personnel Practices – When managers are evaluated and rewarded solely or

primarily on the basis of revenue and sales volumes so that bonuses, commissions,

advancement, and other rewards are dependent on achieving these objectives, they

will come to believe that the company wants them to achieve these objectives any

way that they can, including price fixing.

Opportunities

1. The Job-Order Nature of Business – If orders are priced individually so that

pricing decisions are made frequently and not closely monitored, collusion among

low-level salespeople is more likely.

2. Decentralized Pricing Decisions – When organizations are decentralized so that

pricing decisions are pushed down into the hands of lower divisions of the

organization, price fixing is more likely to happen particularly when such decisions

are not monitored and the division is pressured to perform in a declining market.

3. Industry or Trade Associations – Most industries have organized associations

where the managers of the companies in the industry can meet and discuss common

problems. Allowing salespeople to meet with competitors in trade association

meetings will encourage them to talk about pricing and to begin to engage in price

setting arrangements with their counterparts in competing firms.

Rationalizations

1. Inactive Corporate Legal or H.R. Staff – When legal departments or human

resource departments fail to provide guidance to sales staff until after a problem has

occurred, the sales staff may not understand that price-fixing is a seriously

illegitimate sales activity. Sales staff may then believe that there is nothing

inappropriate about meeting with competitors and making price-fixing agreements.

2. Organizational Culture of the Business – Some companies have a freewheeling

culture where wrongdoing is condoned and goes unpunished so long as bottom line

objectives are met. When an organization’s salespeople feel that price fixing is a

common practice and is desired, condoned, accepted, rationalized, and even

encouraged by the organization, price fixing is more likely.

It is difficult to legislate against many common oligopolistic price-setting practices, however,

because they are accomplished by tacit agreement. Firms may, without ever discussing it

explicitly, realize that competition is not in their collective best interests. Therefore, they

may recognize one firm as the “price leader,” raising their prices in reaction when the

leader decides to do so. No matter how prices are set, however, clearly social utility declines

when prices are artificially raised.

4.4 Oligopolies and Public Policy

Oligopolies are not a modern phenomenon. Toward the end of the nineteenth century,

many businessmen began using anticompetitive practices to force competitors to sell out to

them, in some cases creating gigantic “trust” that would then monopolize the markets. The

trusts would then use its monopolistic power to raise prices for consumers, cut prices for

their suppliers, and continually terrorize their remaining competitors with predatory pricing.

This ultimately resulted in the U.S. Congress in 1887 passing the Interstate Commerce Act

to regulate large railroad companies. Then in 1890, Congress passed the Sherman Antitrust

Act and in 1914 the Clayton Act was passed to prohibit acts that would hinder free and open

competition in the market place.

What should society do in the face of the high degree of market concentration in

oligopolistic industries? There are three main points of view:

First, the Do-Nothing view claims that the power of oligopolies is not as large as it

appears. Though competition within industries has declined, they maintain that competition

between industries with substitutable products has replaced it. In addition, there are

“countervailing powers” of other large corporate groups, the government, and unions that

keep corporations in check. Finally, they argue that bigger is better, especially in the current

age of global competition. Economies of scale, produced by high concentration, actually

lower prices for consumers. By expanding, the companies are able to reduce their prices

and compete more effectively against similarly large foreign companies.

Second, the Antitrust view argues that prices and profits in highly concentrated industries

are higher than they should be and that prices and profits in concentrated industries are

higher than they should be and that monopolists and oligopolists use unfair tactics against

their competitors and suppliers. By breaking up large corporations into smaller units, they

claim, higher levels of competition will emerge in those industries. The result will be a

decrease in collusion, greater innovation, and lower prices.

The third view is the Regulation view, which can be seen as a middle ground between the

other two. Those who advocate regulation do not wish to lose the economies of scale

offered by large corporations, but they also wish to ensure that large firms do not harm the

consumers. Therefore, they suggest setting up regulatory agencies and legislation to control

the activities of large corporations. Some even suggest that the government should take

over the operation of firms where only public ownership can guarantee that they operate in

the public interest.

Whichever view we take, clearly the social benefits of free markets cannot be guaranteed,

and the markets themselves cannot be morally justified, unless firms remain competitive.

Extra Resources

1. “Fair Fight in the Marketplace” (2006) is a 27 minute documentary on antitrust, with

segments on three cases:

Mylan Pharmaceuticals and supply manipulation.

Microsoft’s attack on Netscape in the browser market. Can be purchased at

www.fairfightfilm.org .

Archer Daniels Midland Segment from “Fair Fight in the Marketplace”.

ADM and the lysine price-fixing case (with clips of the conspirators’ meetings in hotel

rooms).

2. Separately, an Archer Daniels Midland Segment from “Fair Fight in the Marketplace” (2009)

a 6.28 minute YouTube clip describing portions of the government’s case against Archer

Daniels Midland. Available by accessing the clip on:

http://www.youtube.com/watch?v=DPXTsPS-hyw

3. Videos on the Lysine Cartel. Seven videos of meetings by United States Department

of Justice, Antitrust Division on YouTube under “Lysine Cartel”.

“Interview with FBI and Mark Whitacre WEAR 3 September 23, 2009”

http://www.youtube.com/watch?v=HZEbbyLRVnE&feature=related

FBI discusses Mark Whitacre on WAND TV October 29, 2009

http://www.youtube.com/watch?v=Ka4U24x4_Bk&NR=1

Ginger Whitacre speaks out about her support for her husband, Mark Whitacre WAND

NEWS Oct 28 2009

http://www.youtube.com/watch?v=Cd6BBwKP3no&feature=mfu_in_order&list=UL

Mark Whitacre Speaking Engagement

http://www.youtube.com/user/ISBGlobal#p/u/7/tZWXg6RhuPU

Distinguished Visitor Series with Mark Whitacre

http://www.youtube.com/watch?v=PulBuTqjLVo&feature=related

Mark Whitacre Interview CBS 47

http://www.youtube.com/watch?v=r7c-e_9thlk&feature=related

FBI Supervisor (retired) discusses Whitacre’s informant role on Pensacola TV

Source: Wear ABC 3

http://www.markwhitacre.com/fbibacksmark.html

Questions for Class Discussion

1. What is the moral justification for free markets? How do anticompetitive practices in

general draw this justification into question?

2. What seven features are necessary to ensure perfectly competitive free markets? Why

is each feature necessary? What else do free competitive markets require besides

these seven features?

3. What is the equilibrium point? How is it achieved? Why are prices above or below the

equilibrium point unjust?

4. Define the principles of diminishing marginal utility and increasing marginal costs.

How are they relevant to the equilibrium point?

5. How do market systems achieve perfect efficiency?

6. In what three ways do perfectly competitive free markets establish perfect morality?

What difficulties remain with the morality of such markets?

7. What is a monopoly? How do they come about? In what ways do they threaten the

morality of the market system?

8. What is an oligopoly? How do they come about? How are they related to monopolies?

9. What types of unethical market practices are common in oligopolies? Why do they

occur? How can they best be prevented?

10. Why are bribes immoral? How can you tell if a payment made in a business

transaction is a bribe or not?

11. What are the three views on public policy in the face of highly concentrated

oligopolistic industries? Which view is correct?

Activities and Assignments

1. Have students, either individually or in groups, research one particular industry,

examining it for signs of monopoly, oligopoly, and unfair market practices.

2. Have students examine one case where a monopoly was broken up and analyze the

effects of the governmental action on the industry and society. Was the action

justified? Beneficial?

3. Have students collect, assemble, and evaluate the continuing dialogue in the media

between the government and companies with reference to alleged unfair market

practices. Let them then act as the Federal Trade Commission. What action should

be taken, if any?

4. Ask students to choose one of the dominant brands and research it to decide if their

dominance in the industry is due to unethical practices or something else.