class: middle, title-slide # Business Ethics — Ethics and Economics ## Market and Morality ### Dennis A. V. Dittrich ### 2022 --- layout: true <div class="my-footer"> <span><img src="img/tcb-logo.png" height="40px"></span> </div> --- # The Perfect Market ## Economic Utilitarianism .row[.col-7[ To maximize economic welfare, we must strive to produce products that maximize benefits to society. Our goal is the so-called allocative and productive efficiency * we use resources in the form that they bring the greatest benefit to society. ]] --- # The Perfect Market ## Efficiency and competitive markets .row[.col-6[ Social Benefit `\(W\)` is total benefit `\(B\)` less total cost `\(C\)` `$$W=B-C$$` An outcome is efficient when social benefit is maximized. This requires that marginal benefit is equal marginal cost: `\(MB=MC\)` Efficiency does not depend on the distribution of benefits and costs ] .col-6[ #### Proof of efficiency of a market 1. The market assigns goods among different buyers to achieve maximized total benefit ($B^*$). 2. The market assigns supply among different sellers to achieve minimized total costs ($C^*$). 3. With `\(B^*\)` and `\(C^*\)` achieved, the market also chooses a quantity such as `\(Q\)` maximizes `\(W=B^*(Q)-C^*(Q)\)` ]] --- # The Perfect Market ## Efficiency and competitive markets: Buyers .row[.col-7[ Total Benefit of buyers is `\(B=\sum_i B_i\)` ...which is maximized when `\(MB_i = MB_j \quad\forall\ i,j\)` Total market demand at the price `\(P_B\)` confronting buyers is `\(Q_D=\sum_i q_i\)` The personal quantities `\(q_i\)` are determined by buyers maximizing utility according to `\(P_B=MB_i\)` Therefore `\(MB_i = P_B = MB_j \quad\forall\ i,j\)`\\ .tip[ #### Allocative efficiency A competitive market efficiently assigns goods among buyers to maximize buyer's total benefit. ] ]] --- # The Perfect Market ## Efficiency and competitive markets: Sellers .row[.col-7[ Total Cost of sellers is `\(C=\sum_i C_i\)` ...which is minimized when `\(MC_i = MC_j \quad\forall\ i,j\)` Total market supply at the price `\(P_S\)` confronting sellers is `\(Q_S=\sum_i q_i\)` Individual sellers' profits are maximized when the quantities `\(q_i\)` are determined by `\(P_S=MC_i\)` Therefore `\(MC_i = P_S = MC_j \quad\forall\ i,j\)` .tip[ #### Productive efficiency A competitive market efficiently assigns supply of goods among sellers to minimize total cost. ] ]] --- # The Perfect Market ### Efficiency and competitive markets: Market Equilibrium .row[.col-7[ A competitive market-adjustment mechanism ensures that the market moves to and remains at the market equilibrium In the market equilibrium `\(Q_D =Q^*= Q_S\)` and `\(P_D=P^*=P_S\)` Therefore `\(MB^*=P^*=MC^*\)` .tip[ The outcome of self-interested behavior of buyers and sellers thus replicates the technical requirement for maximized W. ] ] .col-5[ ![](pic/cs-ps.png) ] ] --- # Welfare Economics .row[.col-7[ (Economic) Welfare is achieved through voluntary exchange that creates (economic) surplus Are any desirable voluntary exchanges in society still possible? If not, we have reached an optimal state. #### Pareto Efficiency No individual or preference criterion can be better off without making at least one individual or preference criterion worse off ]] .row[.col-6[ .tip[ #### First Fundamental Welfare Theorem Under **ideal** assumptions, competitive markets will always lead to an efficient (Pareto optimal) outcome. ]] .col-6[ #### Second Fundamental Welfare Theorem There will be a different competitive equilibrium for every possible allocation of initial endowments. ]] --- # Welfare Economimics ## Cost-Benefit Analysis .row[.col-7[ Sometimes there are no voluntary exchanges available but a new policy could lead to a redistribution such that the winners gain more than the losers lose. #### Kaldor-Hicks Criterion It is not the satisfaction of (individual) consumer preferences per se that is the goal; it is the capacity (of society) to satisfy consumer preferences that is now the **normative** goal. ] .col-5[.question[ Is it morally permissible to implement policies that harm individuals as long as the overall gain to other members of society is larger than the loss? ] ] ] .row[.col-7[ The Kaldor-Hicks reformulation allows for the analysis of policy changes in which harm is done to some parties. As long as winners gain more than losers lose, the outcome is judged to be efficient. ] .col-5[ This may lead to **compulsory** exchange _Losers_ may not be (fully) compensated ] ] --- # Social Market Economy .row[.col-7[ The combination of free market with social compensation #### Advantages 1. Development of human capital through a government financed education system 2. Greater equality of opportunity and thus better economic use of human capital 3. Preservation of human capital by statutory health insurance 4. Social peace through a state guarantee of the subsistence minimum and a redistribution in the form of progressive taxation. ] .col-5[ Social is not socialist but societal. The Social Market Economy balances the disadvantages of market and competition through additional regulations. ] ] --- # Market Failure: External Effects .row[.col-5[ **Externalities** External costs or external benefits are costs or benefits that fall on bystanders * When the market ignores externalities, the market equilibrium can be less than optimal. * Markets with externalities do not maximize social surplus * To evaluate market equilibrium, all costs and benefits must be accounted for. ] .col-7[ **Private cost** A cost paid by the consumer or producer **External cost** A cost paid by people other than the consumer or the producer trading in the market **Social cost** The cost to everyone, the private cost plus the external cost * In markets with externalities, consumers and producers focus on the wrong margin when making their decisions. * Antibiotics consumers ignore part of the cost of their consumption: the increased danger to others as a result of more resistant bacteria. * The increased danger is the “external cost.” ] ] --- # Market Failure: External Effects ### Negative Externality of Antibiotics Use .row[.col-8[ ![](pic/c10-1.png) ] .col-4[ When consumers and producers ignore external costs, they base their decisions on private costs only. Costs are underestimated, and the market `\(Q\)` is greater than the socially efficient `\(Q\)`. At the higher market level of output, costs exceed the private benefits to buyers. A deadweight loss emerges, reducing social surplus. ]] --- # Market Failure: External Effects ### Pollution in a competitive market ![](pic/pollution.png) --- # Taxonomy of Goods .row[.col-6[ #### Samuelson's Classification * One person's consumption subtracts from the total available to others. * One person's consumption **does not** subtract from the total available to others. ] .col-6[ #### Musgrave's Classification * Exclusion is feasible. * Exclusion is **not** feasible. ]] || Rivalry in Consumption| **No** Rivalry in Consumption | |---|:---:|:---:| |Exclusion is Feasible|Private Good| **Club Good**| |Exclusion is **not** Feasible|**Common Pool Resource**|**Public Good**| .center[**Common Goods**] <br/> .row[.col-5[ Better ethics as practiced moral behavior is itself a public good. ] .col-7[ Everyone benefits by cooperative, considerate, and courteous behavior. Social morality is a public good. The benefit is arbitrarily divisible, thus not competitive and no one can be excluded. ]] --- # Market Failure: Public Goods (Non-exclusion) .row[.col-6[ #### Private Goods are excludable and rival * Most goods are private goods. * Private goods can be efficiently provided in competitive markets. * Because they are excludable, there is a strong incentive to pay for and produce them. * Because they are rival, excludability does not lead to inefficiency. * The only people excluded from consuming a private good in a competitive market are those who are not willing to pay. ] .col-6[ #### Public Goods are non-excludable & non-rival * Because they are non-excludable, it is difficult to get people to pay for them voluntarily. * Because they are non-rival, production costs do not significantly change with additional users. * A Free Rider enjoys the benefits of a public good without paying a share of the costs. * Free riders can disrupt market efficiency. * With enough of free riders, public goods will be underprovided by the market. ]] --- # Market Failure: Public Goods (Non-exclusion) ## Inadequate Provision of a Public Good .row[.col-7[ ![](pic/publicgood.png) ] .col-5[ Two neighboring merchants consider whether and how many guards should they hire. * At a wage of 10 merchant 1 hires four guards * Merchant 2 does not hire any guards * Pareto-Optimum would be five guards. ]] --- # Market Failure: Asymmetric Information .row[.col-6[ A used car sales man knows more about the car than the buyer An insured person may know more about his risk then the insurance ] .col-6[ #### Experience Goods quality is difficult to observe in advance #### Post-experience Goods / Credence Goods it is difficult for consumers to ascertain the quality even after they have consumed them ]] --- # Market Failure: Asymmetric Information ## Problems caused by Asymmetric Information .row[.col-6[ If two parties (buyer and seller) involved in a transaction have limited information, one of them may have an advantage Asymmetric information leads to opportunistic behavior * The informed agent may profit from the uninformed agent * Sometimes, with asymmetric information all are worse off than with complete information ] .col-6[ ### Moral Hazard Opportunistic behavior of an informed person; he profits when a less informed person cannot observe an **action**. * quality and quantity of work effort ### Adverse Selection Opportunistic behavior of an informed person; he profits when a less informed person cannot observe some **characteristics** of a good or service. * quality of a used car, experience goods, health ]] --- # Market Failure: Asymmetric Information ## Quality uncertainty kills high-quality goods .row[.col-7[ Often buyers do not know the quality of a good before their purchase decision (experience goods) The lack of complete information increases the risk and hence decreases the value of the good to the prospective buyer Example: low-quality used cars (lemons) may drive high-quality used cars out of the market * Owners of lemons are more likely to sell their cars `\(\hookrightarrow\)` leads to adverse selection ]] .footnote[George A. Akerlof, The Market for "Lemons": Quality Uncertainty and the Market Mechanism, The Quarterly Journal of Economics, Vol. 84, No. 3 (Aug., 1970), pp. 488-500] --- # Market Failure: Asymmetric Information ## Remedies to Asymmetric Information .row[.col-7[ **Screening** the uninformed person improves his information level by gathering information directly or through advice from specialized third parties. **Signaling** the better informed party provides information, for instance by offering a guarantee. **Morality** Ethical behavior in hidden characteristics would prevent the better-informed from betraying the worse-informed. ]] --- # Market Failure: Asymmetric Information .row[.col-7[ .question[ Give an example of the economy in which asymmetric information exists and possible / actually used tools to prevent unethical effects. ]]] --- # Market Failure: Transaction Costs .row[ .col-5[ Market transactions can fail (not be made) due to high transaction costs * costs due to e.g. information acquisition, negotiation, control and enforcement costs, as well as transport costs in a broader sense ] .col-7[ #### Direct transaction costs * Have fallen very sharply in the past decades, leading to the formation of many new markets * Globalization * Internet * International Standards #### Indirect transaction costs Uncertainty of contract fulfillment * written Code of Law reduces related risk * Reputation * **Trust** * _Honor of the merchant_ ] ] --- # Moral Limits to Markets .row[.col-7[ Moral limits to markets arise for at least two distinct reasons: 1. A **repugnance** at selling particular kinds of goods and services that embody beliefs relating to **intrinsic values** 2. A rejection of market price as an allocation mechanism in particular **background circumstances** of trade ]] --- # Intrinsic Values & Moral Goods .row[.col-5[ Using prices to allocate goods may in some cases violate deeply held moral and civic norms. Society tends to use nonprice allocations— * rationing, * first-come/first-served, * favoritism and * lottery to deal with scarcity when community values other than efficiency are paramount. ] .col-7[ #### Moral Goods Selling and consumption of particular goods and services can provoke strong feelings of repugnance and abhorrence when a sale is thought to degrade intrinsic values * moral goods can be eroded and crowded out by their commodification .question[ Give an example of a moral good. ] <br/> #### Slippery Slope If _buying_ a newborn is permissible, could not the same arguments be used to argue for buying a three-year-old child? What about selling photographs of that naked child? ] ] ??? it was once acceptable to sell oneself or one’s child into slavery --- # Intrinsic Acts and Motivational Crowding Out .row[.col-7[ Raising the price of a product usually increases its quantity supplied. #### Instrinsic motivation In contexts in which supply stems from **intrinsic motivation**, money can offend and “**crowd out**” desirable behavior * On a date... pay for dinner or give the money directly to the potential mate? * Blood donations (in some areas) * A fine is a price. ] .col-5[ .question[ What material substance is most necessary to sustain your life here over the next few days? a. drinkable water b. edible food c. other material substance ] <br/> Intrinsic values in society are not always well understood or articulated, but they are often ubiquitous and taken for granted ] ] ] --- # Intrinsic Acts and Motivational Crowding Out .row[.col-7[ #### Virtue ethics Virtue ethicists may not approve of all markets, even if the conditions of perfect competition and other qualities could be met. The reason is that some markets are thought to be inherently destructive of moral character Not everything that can be sold should be sold in a market. * One’s body, * one’s vote, and * one’s identity are sacred ] .col-5[ .question[ Many U.S. states have a death penalty for murderers. Those states could raise substantial sums of money by auctioning on e-Bay the right to pull the electrocution’s lever. Should such a sale be legal? ] ] ] .footnote[ Sandel, M. (2012). What Money Can’t Buy: The Moral Limits of Markets.] --- ### Duties & Rules: Background Circumstances of Exchange .row[.col-6[ #### Personal Relationships Family members and close friends have duties and obligations to each other. Benevolence and fairness are voluntarily assumed and reciprocation expected. In these circumstances, scarce goods are generally given, shared, or allocated based on substantive need. ] .col-6[ #### Gift exchange Gifts do come with strings attached * The recipient of a gift must reciprocate to maintain honor and status * Refusing a gift, or refusing to reciprocate a gift, is considered rude and socially disruptive behavior .question[ Your friend broke their leg and you help them to mow their lawn to ease their suffering and demonstrate compassion. They give you a $20 bill, the opportunity cost of your time. How do you feel? ] ] ] --- ### Duties & Rules: Background Circumstances of Exchange #### Social Groups .row[.col-6[ Individuals belong to social or civic groups such as schools, clubs, and places of worship in which identity is conferred by membership; Members have duties and obligations to each other. * Cooperation deters free riding or shirking ] .col-6[ As a result of their socialization, many people come to expect that valued goods do not always go to the highest bidder * colleges resolve the shortage through favoritism—merit selection based on * grades, * SAT scores, * athletic ability, * leadership, and other attributes. ]] --- ### Duties & Rules: Background Circumstances of Exchange .row[.col-7[ #### Vulnerability In some transactions, one participant may be in a weaker bargaining position due to intrinsic circumstances. * Such transactions may be **coercive** or **exploitative** rather than mutually beneficial. Communities often uphold a **duty** to protect the vulnerable ] .col-5[ Markets are cognizant of vulnerability and bargaining power * Price discrimination * Peak-load pricing <br/> **Just Price Theory** It is immoral to take advantage of buyer vulnerability * Times of Crisis ]] --- # Kantian Ethics and Markets .row[.col-7[ .your-turn[ In the kingdom of ends everything has either a _price_ or a _dignity_. Whatever has a price can be replaced by something else as its _equivalent_; on the other hand, whatever is above all price, and therefore admits of no equivalent, has a dignity ] <br/> If something cannot be reproduced with money, there is nonequivalence between the two concepts. It is immoral to buy or sell something that has intrinsic worth, meaning that there are moral limits to markets. ]] --- # Markets and Dignity .row[.col-7[ Private enterprise can promote human dignity, freedom, equality, and other moral values the rise of an exchange society in Europe promoted the development of moral virtues that previously were discouraged by feudal society * Honesty, * hard work, and * thrift are encouraged by the incentives operating in competitive markets ] .col-5[ Markets can _intrinsically_ promote **dignity** by the absence of controls and _instrumentally_ promote dignity through incentives that create higher income levels * A woman coerced by her bullying husband has an improved set of choices if markets allow her a means to increase her economic independence ]] .footnote[ McCloskey, Deirdre (2006).The Bourgeoise Virtues: Ethics for an Age of Commerce ]