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Course Revision

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.

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Course Revision

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  1. Course Revision From Lecture 7 to 11

  2. Summary of the Previous Lecture In previous lecture we revised the course from lecture 2 to 6.

  3. Learning outcomes We will have a revision of lectures we have studied before and it will help better understand the concepts and eliminate confusions.

  4. 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. • Land • Labor • Capital • Entrepreneur

  5. Lecture 7 Factors of Production in Conventional Economic System

  6. 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.

  7. 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.

  8. Lecture 7 Factors of Production in Islamic Framework All productive inputs are grouped into two categories; • Factor inputs: those inputs that don’t get consumed in the production process. • 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.

  9. 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.

  10. 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.

  11. 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.

  12. 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: • Commodity Market • Factor Market for HFP • Institution of Participation • Institution of Social Insurance

  13. 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.

  14. 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".

  15. Lecture 72. Factor market for HFP 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.

  16. 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: • And in their wealth the beggar and the outcast had due share. (51:19) • The institution of Zakat, Sadaqat and charity. • 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.

  17. 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: • Supply and Demand of Hired Factors of Production • Supply and Demand of Entrepreneurial Factors of Production • Factor Market Equilibrium

  18. Lecture 8Equilibrium in the Factor Markets • 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.

  19. Lecture 8Equilibrium in the Factor Markets2. Supply and Demand of EFP

  20. Lecture 8Equilibrium in the Factor Markets2. 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. Suppose SR = Total resources capable of becoming EFP or HFP Su = Resource employed on ujrat SR – Su = Entrepreneurial supply of resources SS = Supply curve of hired resources So = Resources available at constant opportunity cost DD = Demand curve for the resources

  21. Lecture 8Equilibrium in the Factor Markets2. Supply and Demand of EFP Two things need further elaboration before we go to the demand for entrepreneurial resources. • How the SR is determined • How the remainder SR - Su become EFP.

  22. Lecture 8Human Resources SR • Labor • Entrepreneurs

  23. 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

  24. 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)

  25. Lecture 8Equilibrium in the Factor Markets2. 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.

  26. Lecture 8Equilibrium in the Factor Markets2. Supply and Demand of EFP Factors determining the demand for entrepreneurial resources may be listed as: • Capability to visualize a productive activity that would yield him an expected profit greater than the prevailing level of Ujrat for his resources; • Risks involved in initiating the project; • Supply of other productive resources; • Institutional arrangement conducive for free entry in the market.

  27. Lecture 8Equilibrium in the Factor Markets2. 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.

  28. Lecture 8Equilibrium in the Factor Markets3. Factor Market Equilibrium

  29. Lecture 9The Time Value of Money in Islamic Finance • Money: An Islamic Viewpoint • Cash vs. Credit Price in Sale Transactions • The Monetary Valuation of Time in Credit Transaction • Economic Value of Time

  30. Lecture 9Comparison between Conventional and Islamic Perspective Conventional 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 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.

  31. Lecture 9Comparison between Conventional and Islamic Perspective Conventional Islamic Profit on trade of goods or charging on providing service is the basis for earning profit Time value is the basis for charging interest on capital.

  32. Lecture 9Comparison between Conventional and Islamic Perspective Conventional 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). 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.

  33. Lecture 9Comparison between Conventional and Islamic Perspective Conventional Islamic The execution of agreements for the exchange of goods & services is necessary, while disbursing funds under Murabaha, Salam & Istisna contracts. While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made.

  34. Lecture 9Comparison between Conventional and Islamic Perspective Conventional 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. Conventional banks use money as a commodity, which leads to inflation.

  35. Lecture 10Governing principles of Islamic Banking • The prohibition of interest or riba based transactions • Avoidance of speculations (gharar) • Avoidance of oppression (zulm) • Introduction of Islamic tax (zakat) • Financing of Sharia Approved activities and discouraging the production of goods and services which are not allowed in Islamic values (haram).

  36. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks The functions and operating modes of conventional banks are based on fully manmade principles (capitalism theory). The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah.

  37. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks The investor/lender is guaranteed of a predetermined rate of interest or returns. It promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).

  38. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks Unrestricted profit maximization illustrated by derivatives trading, deposit multiplication, etc. It also aims at maximizing profit but subject to Shariah restrictions.

  39. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks 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. 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.

  40. Lecture 10Comparison of Islamic with Conventional Banks 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. Participation in partnership business is the fundamental function of the Islamic banks.

  41. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks It can charge additional money (penalty and compounded interest) in case of defaults. Islamic banks have no provision to charge any extra money from the defaulters except for compensation and is used for charitable purposes.

  42. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks Banks interest is the main objective. It makes no effort to ensure growth with equity. Importance is given to the public interest or Maslahah. Its ultimate aim is to ensure growth with fairness.

  43. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks For interest-based commercial banks, borrowing from the money market is relatively easier. For the Islamic banks, it must be based on a Shariah approved underlying transaction.

  44. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks 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). Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.

  45. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks The conventional banks give greater emphasis on creditworthiness of the clients. Greater emphasis on the viability of the projects.

  46. Lecture 10Comparison of Islamic with Conventional Banks Islamic banks Conventional banks A conventional bank has to guarantee all its deposits. Islamic 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.

  47. Lecture 11 Islamic Modes of FinancingMurabaha

  48. 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.

  49. 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.

  50. Lecture 11Components of Valid Sale SALE CONTRACT SUBJECT MATTER PRICE POSSESSION • Existence • Ownership • Possession • Valuable • Specific • Halal Purpose • Delivery • Offer/Acceptance • Buyer/Seller • Quantified • Certain • Physical • Constructive

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