Ethics in the Marketplace

Chapter 4
Learning Outcomes
• Understand the case for the morality of free markets as the
best guarantors of capitalist distributive justice, economic
utility, and liberty rights: appreciate the limitations of this
justification
• Understand how the case for the morality of free markets
depends on the assumption of perfect competition.
• Know the defining features and essential presuppositions of
perfectly competitive markets.
• Understand how perfect competition is a useful idealization,
and how the principle of diminishing marginal utility and of
increasing marginal costs interact to determine the
equilibrium price.
• Understand the nature of monopoly markets and their
negative impacts on perfect competition.
• Understand the nature of oligopoly markets, their negative
impacts on perfect competition, and the several different
ways in which oligopolistic influence may be exercised.
• Understand the do-nothing view, the anti-trust view and the
regulative view as competing schools of thought about
appropriate public policy with regard to oligopoly markets.
Introduction
• If free markets are moral it's because they allocate
resources & distribute commodities
– in ways that are just
– that maximize economic utility
– 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:
– distributed: numerous buyers & sellers, none of whom has a
substantial market share
– open: buyers and sellers are free to enter or leave the market
– full and perfect knowledge: each buyer & seller has full and
perfect knowledge of each others' doings
– equivalent goods: goods being sold are similar enough that
buyers don't care whose they buy.
– unsubsidized: costs of producing or using goods is borne
entirely by the buyers & sellers
– 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
– unregulated: no external parties such as governments regulate
the price, quantity, or quality of goods
4.1 Perfect Competition….cont’d
• Breakdown of the seven features
– 1-2 -- openness and distribution -- the "basic conditions"
– 3-6 are "idealizing conditions"
– 7 – non-regulation -- a measure of how free the market
• all real economies are mixed, mixing
– free market elements
– command elements
• regulative and mixtures 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"
• 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
• 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 / need
– 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 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

– 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
– 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.
– Monopolies remove competitive pressures making for productive
efficiency
• 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."
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
• 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. Also see factors that lead to price fixing – P.185
• 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
• No Problem:
View
• 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

4 27
 KEY TERMS
antitrust
• the view that large oligopolistic or monopolistic
companies should be broken up into smaller firms to
reinstate competitive pressures.
countervailing power
• according to John Kenneth Galbraith, the force that
balances and restrains the economic power of any large
corporation or other large corporate group (for example,
a union, or the government).
demand curve
• a line on a graph indicating the maximum that
consumers (or buyers) would be willing to pay for a unit
of some product when they buy different quantities of
that product.
do-nothing
• the view that, in the face of monopolies,
governments should take no action
whatsoever.
equilibrium point
• the point at which the amount of goods
buyers want to buy exactly equals the
amount of goods sellers want to sell, and
at which the highest price buyers are
willing to pay exactly equals the lowest
price sellers are willing to take.
equilibrium price
• the point at which the supply and demand
curves meet (also known as the point of
equilibrium); at this point, the price buyers are
willing to pay for a certain amount of goods
exactly matches the price sellers must take to
cover the costs of producing that same amount.
exclusive dealing arrangements
• when a firm sells to a retailer on condition that
the retailer will not purchase any products from
other companies and/or will not sell outside of a
certain geographical area.
extortion
• when the payee demands the payment by
threatening injury to the payer's interests; it is
not a bribe, and the payer's moral responsibility
may be diminished in proportion to the severity
of the threat.
highly concentrated markets
• oligopoly markets that are dominated by a few
(e.g. three to eight) large firms.
horizontal merger
• the unification of two or more companies that
were formerly competing in the same line of
business.
imperfectly competitive markets
• markets that lie somewhere on the spectrum
between the two extremes of the perfectly
competitive market with innumerable sellers and
the pure monopoly market with only one seller.
manipulation of supply
• when firms operating in an oligopolistic market
agree to limit their production so that prices rise
to higher levels than they would in free
competition.
monopoly competition
• a market system where one seller has a
substantial share of the market (close to 100%)
and no other sellers can enter.
oligopolistic competition
• a market system where a small group of sellers
has a substantial share of the market and no
other sellers can enter; such markets are said to
be highly concentrated.
oligopoly
• a market shared by a relatively small number of
large firms that together can exercise some
influence on prices.
perfect competition
• a market system in which no buyer or seller has
the power to significantly affect the prices at
which goods are being exchanged.
price discrimination
• when a seller charges different prices to different
buyers for identical goods or services.
price fixing
• when firms operating in an oligopolistic market
secretly agree to set prices at artificially high
levels.
price leadership
• related to price setting; when oligopolistic
industries recognize one firm as the firm that
sets the price, that firm is the price leader.
price setting
• when firms in an oligopolistic market
conclude that cooperation, rather than
competition, is in their collective best
interests, they may reach the independent
conclusion that they will all benefit if, when
one firm raises its prices, the others will
follow.
principle of diminishing marginal utility
• each additional item a person consumes is
less satisfying than each of the earlier
items the person consumed.
principle of increasing marginal costs
• after a certain point, each additional item a seller
produces costs more to produce than earlier
items.
pure monopoly
• a market in which a single firm is the only seller
in the market and new sellers are barred from
entering.
regulation
• the view that large companies should not be
broken up to reinstate competitive pressures;
instead, regulatory agencies should be set up to
restrain and control their activities.
retail price maintenance
• when a manufacturer sells to a retailer only
on condition that they agree to charge the
same set retail prices for its goods.
supply curve
• a line on a graph indicating the prices
producers must charge to cover the average
costs of supplying a given amount of a
commodity.
trust
• an alliance of previously competitive
oligopolists formed to take advantage of
monopoly powers.
tying arrangement
• when a firm sells a buyer a certain good
only on condition that the buyer also
purchase other goods from the firm.