It was an example of Steve being Steve: he wanted their back catalog but he also wanted to extract a pound of flesh for their perceived slight more. He had absolutely no problem doing or saying things that put partners (such as the Motorola Rokr presentation a couple years later) or even employees (the time he indirectly joked about getting rid of Tony Fadell on stage) in a bad light/spot. Not saying he didn't often have a point, but he did it in a way that often came off as petty and vindictive. In this case, he probably knew exactly where Apple was heading re: the music business and also probably viewed CD Baby as a competitor to be taken out, so there was that aspect to it as well.

While I don't think they've been (as) vindictive at a corporate level since Steve, Apple as a company has been yanking 'partners' around like this whenever they had the power to for at least the last 15-20 years, depending on the industry.

His responsibility is primarily to enabling his clients (the musicians) to make money from selling their music. Regardless of his feelings Apple was offering a sales channel for his musicians.

CD Baby was the biggest independent music distribution channel at the time (I have to image its been surpassed by Bandcamp now?) and iTunes was very clearly going to be one of the biggest markets available.

Getting the hundreds of thousands artists that use your service banned from iTunes because someone was rude would've been a really terrible business decision.

I don't think the artists would be happy to miss the opportunity to be on iTunes just because Jobs was slow, involved in marketing spin, and specifically obnoxious to this one guy. People and companies (yes, major ones) behave far worse all the time. Boycotts can make sense, but relatively rarely compared to the number of times such bad behavior occurs.