course revision from lecture 7 to 11. summary of the previous lecture in previous lecture we revised...

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