Question

In the period following the invasion of Kuwait by Iraq, oil prices increased significantly, as did the profits earned by many oil companies. Some politicians argued that these profits are undeserved and called for price rollbacks and/or increased taxes. Discuss the pros and cons of these proposals in the context of the various theories of profit.

Answer 1

Classical Theories including ricardo , karl marx focused that the profit is generated from the labour class and later economists pointed that investment as a major source of growth like harod domar. Profit model of Kaldor pointed that investment can keep the profit level increasing but they did not consider the supply shocks which we are seeing in the question. During the invasion of Kuwait, Iraqians burned various wells in Kuwait and due to which there was shortage of oil supply. The accumulated profits which are acquired using the oil price price should be invested again to increase the productivity of the factors of production. But when the entrepreneur piles the pocket using the market inefficiency that brings more distortion to the market. The theories of profit says that entrepreneur needs incentive for production and it is not always the subsistence level of wages which would keep workers in market, therefore when prices increase and the wages do not increase much the real wage would decrease and this would make excess demand for labor. Another disadvantage of this price rise is that which low real wages in hand the demand for consumption goods will decrease and investment thus will decrease. So this spiral is created due to hoarding or supply shock and thus it is illegal and which create inflationary pressure to create slow down.

Some of the advantage of these shocks is only unilateral and not bilateral . The country which increase its production at the cost of other's stock, will not detoriate its inventory and also the capacity effect will work in subsequent period of recession. Another benefit can be the trade balance surplus which will keep the economy's currency at good level.

Thus overall the exogenous supply shock is not good and it is not a market inefficiency due to market participants but due to other reason.