Ethics of Pricing
Daniel T. Ostas
A central tenet of the capitalist creed exhorts the wise business person to buy cheap and sell dear. But can it be unethical to sell a good or service at too high a price? In answering this question, it is helpful to distinguish between legal norms of conduct and alternative ethical concerns. As a general rule, the American common law permits the seller to seek his or her highest price. The common law focuses on consent. So long as the buyer consents to the price, it is presumptively fair and enforceable. The law seeks to assure that the buyer’s consent is meaningful through the doctrines of fraud, duress, undue influence, and unconscionability. It is illegal to lie, to coerce, or to abuse the trust of one’s trading partner. How ever, if the buyer fails to prove fraud or the like, the courts will enforce the contract price, no matter how outrageous that price may appear to an outside observer (Ostas, 1992: 580).
Ethical analysis suggests alternative concerns. First, a ‘‘fair’’ price in an ethical sense may simply mean the market price. Under this view, a price that far exceeds the market would be unfair and unethical even if the buyer consented to it. Historically, the common law embraced such an ethic. Employing the doctrine of laesioenormis, American courts in the eighteenth and early nineteenth centuries routinely in quired into the substantive fairness of contractual prices (Horwitz, 1977: 173–80). Prices that significantly exceeded the market rate were not enforced. The market provided an objective benchmark by which to judge the fairness of pricing. By the mid nineteenth century, the belief in an external notion of value had been discredited in favor of respect for individual autonomy, and the parties alone could determine the value of the commodity or service traded.
Discrimination in pricing raises a second ethical concern. Perhaps it is unethical to discriminate between buyers, demanding a higher price from one class of buyers than another. For example, it is clearly unethical to discriminate between buyers on the basis of race, religion, or ethnicity. ‘‘Red lining’’ in inner city lending provides an example. Price discrimination can appear in other contexts as well. Consider the effects of a natural disaster such as a flood. Electricity is out and there is a sudden demand for gasoline driven electric generators. Can a seller demand its highest price in such a setting? Traditionally, the common law answer is ‘‘yes’’; so long as buyer and seller consent to the price, the price is fair. State legislatures, by contrast, typically answer ‘‘no.’’ Responding to public outcries of ‘‘price gouging,’’ state legislatures typically impose a more generous ethic, demanding that the seller not take undue advantage of the necessitous condition of its trading partners. Price discrimination also can be used as a competitive weapon. A large chain store may charge an unusually low price in hopes of driving its smaller competitors out of business. Again, the common law permits such practices; both ethical analysis and antitrust legislation impose an alternative moral vision of ‘‘fair’’ competition.
The presence of monopoly power also affects the ethics of pricing. Perhaps if a seller has exclusive control over a needed product, fairness would demand that that product be offered at a price that reflects the monopolist’s costs. For example, regulated monopolies, such as utilities, must justify price increases before regulatory commissions, where consumer groups have a right to air their concerns. Since the buyer and seller do not have equal bargaining power, the market is not trusted to generate an ethically acceptable price. Yet in other arenas the law permits the monopolist to seek its highest price. For example, a pharmaceutical company has no legal duty to offer its patented life saving drug at an affordable price. Legally, the company can set its price so as to maximize its profits, even if this means that people in need will not get the drug. Again, ethical analysis suggests an alternative ethic.
Before condemning the common law too harshly, it is important to note that the law itself embodies an ethic. In fact, the common law approach to pricing can be defended on either libertarian or utilitarian grounds (Epstein, 1975: 293). Libertarianism elevates the principles of individual autonomy and individual liberty to positions of the highest order. Positive laws that interfere with the liberty and autonomy rights of individuals are impermissible and immoral. From a libertarian perspective, only the parties to a contract can determine whether a price is fair, and individuals have no duty to share their property rights with others. Utilitarianism will argue that a regime of freedom of contract generates the greatest good for the greatest number. To a utilitarian, personal autonomy and liberty are not ends in themselves, but rather, are means to generating prosperity for the greatest number. Borrowing from Adam Smith, a utilitarian may argue that attempts to regulate prices will interfere with the invisible hand of the market and lead to unintended negative consequences (see invisible hand). Given a competitive free market, the best public policy is one that firmly embraces the right of an individual or company to set its own price.
The common law rests on a presumption that individuals should be empowered to set the terms of their own bargains. Ethical analysis suggests some pragmatic limitations to this presumption. First, a price that exceeds the market price gives evidence that some sort of misrepresentation, duress, or abuse of trust may have occurred during the contract negotiations. Ethical reasoning demands that parties treat one another with respect, providing full disclosure of relevant information, and not taking undue advantage (Shell, 1991: 93). Second, although private autonomy and respect for private property are important ethical concerns, they are not the only ethical concerns raised by pricing. Price discrimination on the basis of prejudice (red lining), to take advantage of a necessitous condition (flood), or to destroy a competitor (chain store) all violate ethical standards of fair play. And finally, the presence of monopoly power generates an affirmative ethical duty to offer one’s product at a price reasonably tied to one’s costs. Such ethical concerns provide a useful supplement to traditional common law principles.
Bibliography
Chamberlin, E. (1985). The Theory of Monopolistic Com petition. Cambridge, MA: Harvard University Press.
Darr, F. (1994). Unconscionability and price fairness. Houston Law Review, 30, 1819 91. (Explores the factors that lead common-law courts to find a price to be unfair and unenforceable.)
Epstein, E. (1975). Unconscionability: A critical reappraisal. Journal of Law and Economics, 18, 293 315. (Defends a general regime of freedom of contract on both utilitarian and libertarian grounds.)
Fried, C. (1981). Contract as Promise. Cambridge, MA: Harvard University Press. (Links the legal duties of contracting with the ethical duties generated by promising.)
Horwitz, M. (1977). The Transformation of American Law: 1780 1860. Cambridge, MA: Harvard University Press. (A seminal work on the history of the common law of contracts.)
Macneil, I. (1980). The New Social Contract: An Inquiry into Modern Contractual Relations. New Haven, CT: Yale University Press. (Identifies a communitarian ethic at the core of contractual endeavors.)
Ostas, D. (1992). Predicting unconscionability decisions: An economic model and an empirical test. American Business Law Journal, 29, 535 84. (Concludes that modern courts require evidence of some sort of negotiating impropriety to hold a price unenforceable.)
Shell, G. (1991). When is it legal to lie in negotiations? Sloan Management Review, 32, 93 101. (Explores the interface between law and ethics in contract negotiations.)
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