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An Interest Free Economic Model

An Interest Free Economic Model. Competitive and Perfect Markets Characteristics of Islamic Markets An Exchange and Two Sector Economy Intertemporal Behavior : Consumption, Savings and Investment Capital Cost and Return Financial and Fiscal Policies The Implications of the Model.

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An Interest Free Economic Model

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  1. An Interest Free Economic Model • Competitive and Perfect Markets • Characteristics of Islamic Markets • An Exchange and Two Sector Economy • Intertemporal Behavior : Consumption, Savings and Investment • Capital Cost and Return • Financial and Fiscal Policies • The Implications of the Model

  2. Perfect Competitive Market • Free Entrance or Exit • Goods are Homogeneous • Market Information Is Accessible • No Resource Fixity • Prices Are Efficient

  3. Complete Market • Comprehensive Private and Public Property Rights • Transferable Property Rights • Exclusive Property Rights • Secured Property Rights • There Are Markets for Every Form and Condition of Exchange • First and Second Rules of Welfare Economics

  4. Characteristics of Islamic Markets 1. Comprehensive property rights & value system a. Multiple forms of private & public ownership & utilization rights b. Ownership right is trust ship

  5. 2. Freedom of contract choice within Islamic value system a. No Reba b. No Gharar غرر c. No worthless value creation اكل المال بالباطل d. No harmful externality لا ضرر و لا ضرار

  6. Definition of Reba & Its Implication • Loan of money or exchange of a commodity or debt for an extra value or service • An alternative to sale, leasing, & joint venture contracts • Formation of the loan market in the economy & legitimacy of earning interest income • Prohibition of Reba is equivalent to elimination of loan market from the economy & illegitimacy of obtaining interest income

  7. Definition of Gharar (غرر )& Its Implication • Full specification of the quantity & quality of the commodity & its value or price in sales contracts • No fraud or unrevealed defection in the product sold • No misuse of information • Market transactions are transparent & secure

  8. No Worthless Activity(اكل المال بالباطل) • Supply of consumer & producer goods in the commodity market renders utility & value added, respectively • Worthless products & services: Alcoholic drinks, gambling, debt based assets & derivatives, pornography, bribery, cheating, unproductive intermediation (speculation), hoarding (كنز), price fixing collusions

  9. No Harmful Activity(لا ضرر و لا ضرار) • All consumption & production activities with negative externality are prohibited • Pollution cost is internalized in the production cost of the firm • Private & social costs tend to become equal

  10. Characteristics of Islamic Financial Markets & Contracts • Both real & financial assets markets may be formed; the latter fully represents the former • Enforcement of Islamic contract rules renders a secure, transparent & competitive market environment • Firms offer both fixed & variable rate of return products

  11. Risk averter consumers will purchase FRR assets : differed payments, installment sales, & hire purchase • Risk lovers purchase VRR assets: profit loss sharing, Modaraba, Mosharaka • Repeated transactions among consumers & producers will bring the asset market into the equilibrium

  12. Envision An Exchange Economy with one type of Intertemporal Contract Differed Payment; Baiamoajal, or Nesia

  13. A Perfect Competitive & Complete Market Assume Price Efficiency

  14. Intertemporal Commodity or Financial Asset Market Assume Justly Distributed Endowments Among Consumers • Excess Supply Agents • Excess Demand Agents • Equilibrium Spot Price P • Equilibrium Future Price P’ • Equilibrium Market Rate of Return • P’/P = 1+ n • Nesiah rate =n=(P’-P)/P

  15. , , • U U E E , O O , , Saving Consumer Demanding Consumer Consumption & Savings Over Time

  16. C” The Effect of Increase in n upon Consumption and Savings Decision

  17. n Nesia rate • n Nesia rate • S D O O Goods or Assets Goods or Assets

  18. n Nesia rate D S n* O Q* Goods or Assets

  19. A,y1 H A y1 O G S y0 W X yo,I I An Islamic Investment Model

  20. n The Investment Function O I

  21. Investment and Savings Functions n n S S* H KH=AB K A n2 B E n1 D+I I D I O I*=S O Q Q1 Q2 Q*

  22. (1+n)

  23. = … ,…, ( n,

  24. Financial Policy Fiscal policy Stimulating Contractionary • Stimulating • Contractionary Policy Implementation

  25. Implications of Eliminating Reba for the Economy • Elimination of Loan Market • Extension and Deepening of Financial Markets

  26. Implications of Eliminating the Loan Market • Nominal & Real Income are Proportionate • Cost of Capital is Determined Endogenously • Rapid Adjustment to External Shocks • Market Stability Achieved • Saving Incentives Are Maintained

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