2 theories of profits can be applied with regards to the scenario of oil companies gained huge profits due to the increased oil price during the period that led to the war in Iraq.
a.Risk-Bearing Theory of Profit:
This theory applies when oil companies dare to take the risk to make investment in ‘high-risk countries’ such as Iraq. Knowing that their investments are not entitled with a fixed rate of return (due to the risk), normal profits for high-risk taker companies are expected to be higher than normal profits for low-risk takers. As the Iraq’s economical activities disrupted due to the threat of US attack, these oil companies gained the advantage of the increase of oil price due to shortage in supplies in the market (refer next theory of profit)
b.Temporary Disequilibrium Theory of Profit:
In nature, crises will have a negative impact to the market and economic activities. Periods before war of Iraq has led to a temporary disequilibrium of oil supply due to the high possibility and risk of an actual war to take place. Thus, many companies decided to reduce the production which then caused oil shortages in the market. Demand remains constant. Oil price increased dramatically (as high as $40 per barrel) to cater the demand. Oil companies earned rate of return above their long-run normal return level.
With regards to the pros of these proposals, consumers will benefit because the price of oil will remain at a static equilibriumprice regardless of any possible incidents (like war). The oil companies will not have the advantage of gaining higher profits as a result of temporary disequilibrium situation.
As for the cons, definitely, the oil companies’ profit will be reduced. As the price of oil is roll-back to its original price (the same as normal situation), there is no point of taking the risk in...