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Course Revision
From Lecture 7 to 11
Summary of the Previous Lecture
In previous lecture we revised the course from lecture 2 to 6.
Learning outcomes
We will have a revision of lectures we have
studied before and it will help better understand
the concepts and eliminate confusions.
Lecture 7: Factors of Production inIslamic Economic Framework
First we see what are the factors of production in conventional economic system:• Factors of production are the Inputs that provide a
productive service in a production process.• Conventional economic theory suggests four factors
of production, i.e.1. Land2. Labor3. Capital4. Entrepreneur
Lecture 7 Factors of Production in Conventional Economic System
Name of the Factor
Owner of the Factor
Reward of the Factor
Nature of the Factor
Land Landlord Rent Natural resources
Labor Laborer Wages Human factor
Capital Money Lender Interest Man made factors
Entreprise Entrepreneur Profit Man made factor
Lecture 7: Factors of Production in Conventional Economic System
• Capital is recognized as money and physical capital.
• Conventional literature suggest that reward of capital is
interest rate against the services of the physical capital too
e.g. the capital equipment etc. (Scott and Nigro, p.314;
Samuelson, p.557).
• But the reward for Land and Labor is measured as rent and
wage for their services.
Lecture 7: Factors of Production in Conventional Economic System
• Capital equipment like other factors of production (land, and
labor) provide services but the compensation process is
different which creates confusion.
• Interest rate should enter into the rewards of factors of
production only if money or finance is treated as an explicit
separate factor of production capable of providing a service.
Lecture 7 Factors of Production in Islamic Framework
All productive inputs are grouped into two categories;
1. Factor inputs: those inputs that don’t get consumed in the
production process.
2. Consumed inputs: those inputs that are consumed during the
production process and lose their original nature and shape,
e.g. fuel, raw cotton, plastic, etc.
Lecture 7Factors of Production in Islamic Framework
Money as factor of production:
• Money is recognized as “consumed input” and become useful
only when converted into consumed input or factor input.
• Money itself is not considered a factor of production but it
has the potential to become a factor of production.
Lecture 7Rewards for the Factors of Production
• Hired Factors of Production (HFP): all those factors that earn
ujrat (wage or rent), e.g. labor earns wage, land earns rent,
machinery earns rent etc.
• Entrepreneurial Factors of Production (EFP): the factors that
face risk instead of earning a fixed wage or rent, e.g.
entrepreneur, capital assets employed in the production
process.
• Factor inputs can become HFP or EFP.
Lecture 7Rewards for the Factors of Production
• For factor inputs that opt to become HFP the reward is ujrat
or rent; money not being a factor input can not earn any ujrat
or rent (interest). All the consumable inputs can neither be
rented nor they can earn any ujrat.
• Those factor inputs that opt to become EFP the reward is
profit (or loss) against the risk associated with new business
venture.
Lecture 7: Institutional Framework in Islamic Economic System
Some of the institutional frameworks that explain the nature of
factors of production and factor market are as follows:
1. Commodity Market
2. Factor Market for HFP
3. Institution of Participation
4. Institution of Social Insurance
Lecture 71. Commodity Market
• Islam rates trading activities very high and the institution of
commodity market is one of the most important institutions
in Islam.
• Islamic laws regulate the commodity market operations and
ensure the free market system with restrictions on the bad
practices (monopoly) and misallocation of the resources.
Lecture 72. Factor market for HFP
• Only those goods/resources can be rented or hired which are
not "consumed“ while they are used.
• Renting or hire is the sale or purchase of the benefits/services
of physical assets or resources including human resources.
• The assets or resources that generate benefits in the form of
real goods (like tree giving fruits or animals giving milk) can
not be rented for such benefits.
• Financial resources can not be rented because they can not
generate any service without being "consumed".
Renting of land for agricultural purposes:
• There is some difference of opinion about renting land for
agricultural purposes. A minority of Islamic scholars disallow
renting of land for agricultural purpose. The majority of Islamic
scholars allow renting of land for agricultural purpose within
the general principle of renting, which is, that any physical
resource that is capable of generating a productive service is
capable of being rented or hired.
• Land is supposed to be just like a machinery which provides the
service of being productive when the inputs are used.
Lecture 72. Factor market for HFP
Lecture 74. Institution of Social Insurance
Islam ensures the well being and livelihood of the people. The
institution of social insurance consists of the following factors:
a. And in their wealth the beggar and the outcast had due
share. (51:19)
b. The institution of Zakat, Sadaqat and charity.
c. The system ensure minimum living needs for everyone so
the entrepreneurial factors would be encourage to take risks
the demand for EFP would increase which means welfare of
the people.
Lecture 8Equilibrium in the Factor Markets
Equilibrium is phenomenon of the forces of supply and demand in the market. We will study the topic under the following headings:
1. Supply and Demand of Hired Factors of Production2. Supply and Demand of Entrepreneurial Factors of
Production3. Factor Market Equilibrium
Lecture 8Equilibrium in the Factor Markets
1. Supply and Demand of Hired Factors of Production
• Marginal productivity will determine the demand for the
human resources and physical capital.
• Supply of labor will be determined by the marginal utility of
leisure to the laborer.
• Supply of capital goods will be determined by the opportunity
cost of producing capital goods.
• The rental of capital goods will really be rental not the
interest.
Lecture 8Equilibrium in the Factor Markets
2. Supply and Demand of EFP
Lecture 8Equilibrium in the Factor Markets
2. Supply and Demand of EFP
The supply of EFP resources which could also be hired will be determined as a residual out of the total stock of resources left over after getting employed on Ujrat.SupposeSR = Total resources capable of becoming EFP or HFP
Su = Resource employed on ujrat
SR – Su = Entrepreneurial supply of resources
SS = Supply curve of hired resourcesSo = Resources available at constant opportunity cost
DD = Demand curve for the resources
Lecture 8Equilibrium in the Factor Markets
2. Supply and Demand of EFP
Two things need further elaboration before we go to the
demand for entrepreneurial resources.
a. How the SR is determined
b. How the remainder SR - Su become EFP.
Lecture 8Human Resources SR
• Labor
• Entrepreneurs
Lecture 8Labor Supply
• Measured in terms of time (man hour)
• Labour supply = no. of workers x no. of working hours per worker
• Factors affecting labour supply:– Size of population– Size of working population– No. of working hours
Lecture 8How to increase labor supply?
• population growth (by natural growth or
immigration)
• monetary rewards
• import of labor from other countries
• retirement age (e.g. from 60 to 70)
• school leaving age (e.g. from 16 to 17)
Lecture 8Equilibrium in the Factor Markets
2. Supply and Demand of EFP
• SR for human resources: Size of the population and the growth
rate of the population. Human resources if can’t get ujrat to
their desired level may sit idle or become EFP.
• S for capital goods in the country will be the total output of
capital goods in the country minus exports plus imports. The
Stock of capital goods more than the demand in the economy
will become EFP otherwise will be depleted by the annual
payment of Zakat.
Lecture 8Equilibrium in the Factor Markets
2. Supply and Demand of EFP
Factors determining the demand for entrepreneurial resources
may be listed as:
a. Capability to visualize a productive activity that would yield
him an expected profit greater than the prevailing level of
Ujrat for his resources;
b. Risks involved in initiating the project;
c. Supply of other productive resources;
d. Institutional arrangement conducive for free entry in the
market.
Lecture 8Equilibrium in the Factor Markets
2. Supply and Demand of EFP
The supply of different EFPs raises each other's demand. Thus
availability of entrepreneurial capital i.e., risk bearing capital will
raise the demand for the entrepreneurial human resources and
vice versa.
Lecture 8Equilibrium in the Factor Markets
3. Factor Market Equilibrium
Lecture 9The Time Value of Money in Islamic
Finance
1. Money: An Islamic Viewpoint
2. Cash vs. Credit Price in Sale Transactions
3. The Monetary Valuation of Time in Credit Transaction
4. Economic Value of Time
Lecture 9Comparison between
Conventional and Islamic Perspective
Conventional
Money is a commodity besides medium of exchange and store of value. Therefore, it can be sold at a price higher than its face value and it can also be rented out.
Islamic
Money is not a commodity though it is used as a medium of exchange and store of value. Therefore, it cannot be sold at a price higher than its face value or rented out
Lecture 9Comparison between
Conventional and Islamic Perspective
Conventional
Time value is the basis for charging interest on capital.
Islamic
Profit on trade of goods or charging on providing service is the basis for earning profit
Lecture 9Comparison between
Conventional and Islamic Perspective
Conventional
Interest is charged even in case the organization suffers losses by using bank’s funds. Therefore, it is not based on profit and loss sharing.
Islamic
Islamic bank operates based on profit and loss sharing. In case, the businessperson has suffered losses, the bank will share these losses based on the mode of finance used (Mudharaba, Musharakah).
Lecture 9Comparison between
Conventional and Islamic Perspective
Conventional
While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made.
Islamic
The execution of agreements for the exchange of goods & services is necessary, while disbursing funds under Murabaha, Salam & Istisna contracts.
Lecture 9Comparison between
Conventional and Islamic Perspective
Conventional
Conventional banks use money as a commodity, which leads to inflation.
Islamic
Islamic banking tends to create link with the real sectors of the economic system by using trade related activities. Since, the money is linked with the real assets therefore it contributes directly in the economic development.
Lecture 10Governing principles of Islamic Banking
1. The prohibition of interest or riba based transactions
2. Avoidance of speculations (gharar)
3. Avoidance of oppression (zulm)
4. Introduction of Islamic tax (zakat)
5. Financing of Sharia Approved activities and discouraging the
production of goods and services which are not allowed in
Islamic values (haram).
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
The functions and operating
modes of Islamic banks are
based on the principles of
Islamic Shariah.
Conventional banks
The functions and operating
modes of conventional banks
are based on fully manmade
principles (capitalism theory).
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
It promotes risk sharing
between provider of capital
(investor) and the user of
funds (entrepreneur).
Conventional banks
The investor/lender is
guaranteed of a
predetermined rate of interest
or returns.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
It also aims at maximizing
profit but subject to Shariah
restrictions.
Conventional banks
Unrestricted profit
maximization illustrated by
derivatives trading, deposit
multiplication, etc.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
In the modern Islamic banking
system, it has become one of
the service-oriented functions
of the Islamic banks to be a
Zakat collection centre and
they also pay out their Zakat.
Conventional banks
Conventional banks do offer
the service of Zakat deduction
but the depositors are
reluctant to pay Zakat from
their accounts in conventional
banks.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
Participation in partnership
business is the fundamental
function of the Islamic banks.
Conventional banks
Lending money and getting it
back with compounding
interest is the fundamental
function of the conventional
banks. Money is a commodity
and the motivation.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
Islamic banks have no
provision to charge any extra
money from the defaulters
except for compensation and is
used for charitable purposes.
Conventional banks
It can charge additional money
(penalty and compounded
interest) in case of defaults.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
Importance is given to the
public interest or Maslahah. Its
ultimate aim is to ensure
growth with fairness.
Conventional banks
Banks interest is the main
objective. It makes no effort to
ensure growth with equity.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
For the Islamic banks, it must
be based on a Shariah
approved underlying
transaction.
Conventional banks
For interest-based commercial
banks, borrowing from the
money market is relatively
easier.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
Since it shares profit and loss,
the Islamic banks pay greater
attention to developing project
appraisal and evaluations.
Conventional banks
Since income from the
advances/loans is fixed, it gives
little importance to developing
expertise in project appraisal
and evaluations. Risks are
transferable at a price
(insurance).
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banks
Greater emphasis on the
viability of the projects.
Conventional banks
The conventional banks give
greater emphasis on
creditworthiness of the clients.
Lecture 10Comparison of Islamic with
Conventional Banks
Islamic banksIslamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the Mudarabah concept, client have to share in a loss position.
Conventional banks
A conventional bank has to
guarantee all its deposits.
Islamic Modes of FinancingMurabaha
Lecture 11
Lecture 11Definition of Murabaha
Murabaha is a particular kind of sale where seller expressly
mentions the cost it has incurred on purchase of the asset(s) to
be sold and sells it to another person by adding some profit,
which is known to buyer.
Lecture 11What is Sale?
Sale is defined in the Islamic Fiqh as an
Exchange of a thing of value with another thing of value, with
mutual consent.
Lecture 11Components of Valid Sale
SALE
CONTRACT SUBJECT MATTER
PRICE POSSESSION
•Offer/Acceptance Buyer/Seller
•Existence•Ownership•Possession•Valuable•Specific•Halal Purpose•Delivery
•Quantified•Certain
•Physical•Constructive
Model - ITwo party relationship
• Bank – customer
Model - IIThree party relationship
• (Bank-vendor) and customer
Model - IIIThree party relationship
• Bank and (vendor-customer)
Lecture 11
Bank/VendorCustomer 1
2
3
Lecture 11MODEL I – GRAPHICAL PRESENTATION
Vendor
Customer Bank
1
2
3
4
6
5
Lecture 11Model II – Graphical Presentation
Lecture 11Model III – Graphical Presentation
Bank
Vendor4
3
2
1
5
5
6Offer Acceptance
Customer
7
Summary of the Lecture
We revised lectures from 7 to 11