MANAGERIAL ECONOMICS

(ECON 2210)

INDIVIDUAL ASSIGNMENT

MANAGERIAL ECONOMICS FROM ISLAMIC

PERSPECTIVES (PROFIT MAXIMIZATION)

NAME MATRIC NO.

AFIFAH NABILAH BT MOHAMAD SAFEI 1321976

Lecturer’s Name : Madam Suharni Maulan

Section : 1

Session : Semester 1, 2015/2016

Submission Date : 8 December 2015

TABLE OF CONTENTS

INTRODUCTION ..............................................................................................................................3

OBJECTIVES OF ISLAMIC ECONOMICS.......................................................................................4

PROFIT MAXIMIZATION IN ISLAMIC PERSPECTIVE ................................................................6

PROFIT MAXIMIZATION THEORY IN MANAGERIAL ECONOMICS ........................................8

INTRODUCTION

Economic system is an organized way in which a state or nation allocates its resources

and apportions goods and services in the national community. In other words, it is the

combination of entities that interact with one another according to a particular plan in order to

fulfill the economic objectives of a society. Conventional economic system is the economic

system that was derived from the theories developed by the western scholars such as Adam

Smith, Joseph Schumpeter, Jeremy Bentham and Max Weber. It is already been adopted and

applied in the society. It has been widely practiced in today’s societies all around the world.

Conventional economic system has some features including the concept of absolute

scarcity, self-interest based, absolute freedom, materialism and utilitarianism, and positivism

versus norms. The concept of absolute scarcity stated that all resources are limited and human

wants are unlimited. Therefore, not all human wants can be fulfilled. Humans need to make a

choice on what they will have and what they must forgo. Since there is no free lunch in this

world, the choice that humans made will involve the opportunity costs of the other choices

that were forgo in the process of making the choice.

Conventional economic system focused the priority on gaining self-interest rather than

public interest. An economist should focused on making decision that will gain an individual

self-interest first before thinking on public interest. This assumption was introduced by Adam

Smith in the theory of ‘invisible hand’ where it said the policies often were less effective in

advancing social welfare than were the self-interested acts of individuals. An individual

should act on his own in order to gain their own self-interest and does not need assistance

from the government to do that.

Absolute freedom in conventional economic system is reflected from the expression of

‘the survival of the fittest’ where only the strong one will survive in which, economists can do

anything that is possible in order to survive in the economic world. There is no restriction on

what they can and cannot do. In other words, absolute freedom does not involve any laws or

morality since people can do anything to achieve their individual goals including giving bribe

to expand their influences in economic world.

Conventional economic system also focused on materialism and utilitarianism.

Materialism can be defined as the desire to acquire and consume material goods. In economic

perspective, materialism is largely focused on maximizing the profits. In making an economic

decision, an economist should compare between marginal benefits and marginal costs of

choosing each options and choose the option which gives more marginal benefits and

consume less marginal costs.

While, utilitarianism is the ethical doctrine that virtue is based on utility, and that

conduct should be directed toward promoting the greatest happiness of the greatest number of

persons. Individuals look for and pursue the opportunities to increase their utility where they

allocate their time, energy and money to maximize their satisfaction. An economist should

makes a decision that will maximize the satisfaction of the greatest number of persons.

In conclusion, conventional economic system has been practiced in the society since

long time ago until today. Even, the economic systems that are taught in schools and

universities are mainly come from conventional economic system. And we can see in the later

discussion on how profit maximization is being viewed in both Islamic and conventional

economics.

OBJECTIVES OF ISLAMIC ECONOMICS

The objectives of Islamic economics are represented in many terms. Some use the

word objectuve itself and some use the word feature, principle, axiom and philosophy of

Islamic economics. Based on the literature and due to different approaches to project the

objectives, the objectives of Islamic economics have been divided as philosophical-based

objectives and operational-based objectives.

The philosophical-based objectives are those objectives which relate to the inner

dimension of Islamic in general and drive towards its infinite goals. While, operational-based

objectives are those measureable, testable outcomes and directly relate to human worldly

activities. These objectives then were classified into six themes namely as economic-based

objective, social-based objective, justice-based objective, self-based(inner-self) objective,

harm elimination objective and state participation objective.

Details of the objectives have been shown in the table below:

PROFIT MAXIMIZATION IN ISLAMIC PERSPECTIVE

In Islam, the market is an institution that equilibrates the behaviors of consumers and

firms to ensure greater welfare in this world, as well as the greatest reward in the hereafter

through dealings involving profit maximization.1 In an Islamic framework, it is also accepted

that a firm’s behavior must be guided by Islamic values and ethics. The motivation of a firm

in the Islamic framework is profit and public good compared to the mainstream economics

where the firm’s motivation is solely to maximize profits.2

The real issues in relation to profit-maximization from the Islamic social justice

viewpoint :

fairness of the firms’ actions towards the buyers in the product market

the equitability of the consumers towards the sellers, especially labor, in the factor

market; and

the usage of profit from the activity

These objectives could be further explained through (Chaudry, M. S., 2003) :

Achievement of al-Falah: It is all about the spiritual, moral and socio-economic

success in this world and in the world hereafter. In Islamic economics, profit is

allowed but maximization of profit is denounced by many Islamic economists. It

includes reward and sin which means Allah’s blessing and also His wrath (Al-Qasas:

77)

Fair and equitable distribution: Wealth should not be allowed to be concentrated in

only a few hands but instead should be freely circulated among everyone. The Islamic

firm would view profit from a more socially beneficial perspective. (Al-Hashr: 7)

Provision of basic human needs: It is important that the society is provided with all

basic necessities to live like food, clothing and shelter. A hadith narrated by Tirmizi:

“The son of Adam has no better right than that he would have a house wherein he may

live, and a piece of cloth whereby he may hide his nakedness, and a piece of bread

and some water.”

1 Samad, A., 2008

2 Ali S.A

Establishment of social justice: To make economic resources distribution fair and

just, an elaborate system of Zakah and Sadaqah has been established in the Islamic

economic system. Many restrictions have been put in place to bar an individual

earning wealth through unfair, illegal and unjust measures.

Promotion of brotherhood and unity: Islam sets out the foundations of sympathy,

brotherhood (ikhwan), friendship and love among all the members of Ummah. For a

firm, it will automatically gear up its motive towards the interest of the Ummah rather

than just focusing in achieving maximum profit. Social accord will be attained and full

cooperation will exist between all parties. As Allah said in the Quran, "They ask you,

[O Muhammad], what they should spend. Say, "Whatever you spend of good is [to be]

for parents and relatives and orphans and the needy and the traveler. And whatever

you do of good - indeed, Allah is knowing of it." (al-Baqarah: 215)

Achievement of moral and material development: It can be achieved particularly

through Zakah. Through the paying out of Zakah particularly in regards to firms who

obtains profit, consumption and investment would be boosted. Through the multiplier

effect, there will be a greater growth of national income. Unemployment will be

minimized and resources would be fully and efficiently utilized. As the Quran says,

“And whatever you give for interest to increase within the wealth of people will not

increase with Allah . But what you give in zakah, desiring the countenance of Allah -

those are the multipliers” (ar-Rum: 39)

Circulation of wealth: Allah threatens that there will be calamitous penalty for the

persons responsible for this dreadful offense, "This is what you hoarded for

yourselves, so taste what you used to hoard" (at-Taubah: 34–35)

Elimination of exploitation: Firstly is the abolition of interest or usury as it is the

worst form of human exploitation. For those who have only profit-maximization as

motivation, they would totally disregard this. Allah wages war against those who are

involved in this crime. The second measure is the exploitation of human in relation to

slavery. To maximize its profit, a firm might pay its workers less than they are worth

or pay the wages late or may not pay at all. A hadith says, “Pay the labourer his

wages before his sweat dries up” (Ibn Majah)3

PROFIT MAXIMIZATION THEORY IN MANAGERIAL ECONOMICS

In the neoclassical theory of the firm, the main objective of a business firm is profit

maximisation. The firm maximises its profits when it satisfies the two rules:

(i) MC = MR and,

(ii) MC curve cuts the MR curve from below.

Maximum profits refer to pure profits which are a surplus above the average cost of

production. It is the amount left with the entrepreneur after he has made payments to all

factors of production, including his wages of management. In other words, it is a residual

income over and above his normal profits. The profit maximisation condition of the firm can

be expressed as:

Maximise P(Q)

Where P(Q)=R(Q) - C(Q)

Where P(Q) is profit, R(Q) is revenue, C(Q) are costs, and Q are the units of output sold.

The two marginal rules and the profit maximization condition stated above are applicable

both to a perfectly competitive firm and to a monopoly firm.

Assumptions:

The profit maximisation theory is based on the following assumptions:

1. The objective of the firm is to maximise its profits where profits are the difference

between the firm’s revenue and costs.

2. The entrepreneur is the sole owner of the firm.

3 http://www.slideshare.net/Maisarah165/profit-maximization-from-islamic-perspective

3. Tastes and habits of consumers are given and constant.

4. Techniques of production are given.

5. The firm produces a single, perfectly divisible and standardised commodity.

6. The firm has complete knowledge about the amount of output which can be sold at

each price.

7. The firm’s own demand and costs are known with certainty.

8. New firms can enter the industry only in the long run. Entry of firms in the short run is

not possible.

9. The firm maximises its profits over some time-horizon.

10. Profits are maximised both in the short run and the long run.

Given these assumptions, the profit maximising model of firm can be shown under perfect

com­petition and monopoly.

1. Profit Maximization under Perfect Competition Firm:

Under perfect competition, the firm is one among a large number of producers. It cannot

influence the market price of the product. It is the price-taker and quantity-adjuster. It can

only decide about the output to be sold at the market price. Therefore, under conditions of

perfect competition, the MR curve of a firm coincides with its AR curve.

The MR curve is horizontal to the X-axis because the price is set by the market and the

firm sells its output at that price. The firm is thus in equilibrium when MC= MR= AR (Price).

The equilibrium of the profit maximisation firm under perfect competition is shown in Figure

1 where the MC curve cuts the MR curve first at point A.

It satisfies the condition of MC = MR, but it is not a point of maximum profits because

after point A, the MC curve is below the MR curve. It does not pay the firm to produce the

minimum output when it can earn larger profits by producing beyond OM. It will, however,

stop further production when it reaches the OM level of output where the firm satisfies both

conditions of equilibrium. If it has any plans to produce more than OM1 it will be including

losses, for the marginal cost exceeds the marginal revenue after the equilibrium point B. Thus

the firm maximises its profits at M1 B price at the output level OM1.

2. Profit Maximisation under Monopoly Firm:

There being one seller of the product under monopoly, the monopoly firm is the industry

itself. Therefore, the demand curve for its product is downward sloping to the right, given the

tastes and incomes of its customers. It is a price-maker which can set the price to its

maximum advantage. But it does not mean that the firm can set both price and output. It can

do either of the two things.

If the firm selects its output level, its price is determined by the market demand for its

product. Or, if it sets the price for its product, its output is determined by what the consumers

will take at that price. In any situation, the ulti­mate aim of the monopoly firm is to maximise

its profits. The conditions for equilibrium of the monopoly firm are:

1) MC = MR<AR (Price), and

2) The MC curve cuts the MR curve from below.

In Figure 2, the profit maximising level of output is OQ and the profit-maximisation price

is OP. If more than OQ output is produced, MC will be higher than MR, and the level of

profit will fall. If cost and demand conditions remain the same, the firm has no incentive to

change its price and output. The firm is said to be in equilibrium.4

4 http://www.yourarticlelibrary.com/economics/profit-maximisation-theory-assumptions-and-criticisms-

economics/28998/

IMPLEMENTATION OF PROFIT MAXIMIZATION MODEL

Under this profit maximization model, a variety of services being offered by

conventional banks may also be offered by Islamic banks without any need for modification

in the nature of the products, as long as, there is no debtor-creditor relationship involved in

the process. If there exists a debtor-creditor relationship, then the element of riba is involved.

Services leading to creation of a debtor-creditor relationship often involve a mix-up of fees

for service rendered and interest or riba for lending of money.

In a situation where loan is involved, it will be dangerous for Islamic bank to receive

revenues or fees based on percentage of the loan value, in order to ward off suspicion of riba.

But, loan is not involved; revenue or fee will be based on the benefit to the customer on one

hand, and the efforts exerted by the bank or work done, on the other. And, where these two

elements are involved, the fee is considered as amount for the benefit passed and cost

incurred, and certainly not as a percentage of the value of loan. It should be noted that the

core business of conventional banking system is buying and selling of funds.

For Islamic banks to run its business, it must find ways to buy and sell funds without

engaging in transactions and contracts involving riba and gharar. The concept of Islamic

banking is essentially based on the idea that Islam prohibits riba, but permits trade and profit-

loss sharing arrangements. The two forms of profit-loss sharing are mudaraba and musharaka.

In mudaraba, one party provides the capital, while the other party manages the business as

wakil. Profit is shared in pre-agreed ratios and loss, if any, unless caused by the negligence or

violation of the terms of the agreement, is borne by the provider of capital. In musharaka,

partners pool their capital to undertake business. All providers of capital are entitled to

participate in management but are not necessarily required to do so. Profit is distributed

among the partners in pre-agreed ratios, while loss is borne by each partner strictly in

proportion to the respective capital contribution.5

5 Concept of Profit Maximization Model in Islamic Commercial Banking System and its Weakness (2011)

CONCLUSION

I believe that profit maximization can still be applied in order to achieve the desired

outcomes of an Islamic economy system. Although the present economic environment and the

values of mainstream economy may not completely imitate the ideal values of Islam, we do

hope that the analysis of this paper provides valuable knowledge in supporting our Islamic

economic framework.

The government must undertake this responsibility to ensure that the goal is attained

and coincide with the market of society. I believe that economic and social justice values of

the firm need to be in same discussion. Islam via the concept of vicegerency visualizes

shareholders’ financial resources plus society’s economic resources, holding their property in

trust for the benefit of the whole society with ultimate goal to gain the blessing of Allah.

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Islamic Perspectives on Profit Maximization. (2012). Journal of Business Ethics, 467-475.

doi:10.1007/s10551-012-1530-0

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