Lecture: Principles of Islamic economics

Lecture: Principles of Islamic economics

 Comparative economic analysis:

Types of economy:

1. Market Economy: is one in which individuals and private firms make the major decision about production and consumption Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services

Example-UK (came to close in 18^th century)

2. Command Economy: is one in which the government makes all important decisions about production and consumption.

Example-ex-soviet union

3. Mixed Economy: it includes the elements of both market and command economy. Example-almost all economy of the world,Bangladesh,India etc

4. Islamic Economy: the economy which runs according to the law of welfare, justice and Islamic Shariah.

Example-Medina state in 7^th century, Iran (came to close)

Consumer theory in islamic economics:

1. A brief overview of conventional theory of consumer behavior:

The essence of the theory:

1. References of consumer. Example: Mango>Apple
2. Transitivity. Example: Mango>Apple>Orange. So Mango > orange
3. Choice space.

5. Indifference curve (IC) represents the References of consumer. Example: Higher IC means higher satisfaction or Utility and Lower IC means Lower satisfaction or Utility.

2. Some basic observation from an Islamic perspective:

1. In conventional economics, the term economic rationality says that the desire of consumer is the best determinants of his preference. While natural definition of Islamic rationalism says rationality means different things to different people.

Example: Alcohol is allowed to someone in a society

a.       Versus

2. Alcohol is not allowed to someone in a society

2. The indifference curve analysis says that goods in question are perfect substitute. This is not accepted practically. So MRS is not valid.
3. Consumption is assumed to be selfish.
4. Demand depends on price and income but tastes and preferences are ignored. Such as Religion, belief, moral values etc.
5.  Choice space considers the consumption decision between the present and future consumption. Example: it considers worldly needs but ignores the Heavenly needs.
6. Failed to identify the preferences of the needs. Such as which goods and services are essentials or comforts or luxuries.

3. Basic concept:

a)      Islamic consumer:

 A consumer whose behavior is not against the norms of Islam

b)      Characteristics of Islamic consumer:

1.      Design the consumption pattern to please Allah, the omnipotent.

Gratefulness

An act of worship (Ibadah)

2.      Spending: 2 categories.

                           i.      Fulfill worldly satisfactions or utility including present and future consumption

                         ii.      Spending for Hereafter life induced by Imaan

Imaan:

3.      Spend in moderation.example: neither miser nor extravagant

4.      Does not hoard his wealth. He would save and Invest and pay Zakah.

5.      Consume Halal goods and services and ignore Haram goods and services

Example: Goods-Beef-Halal, Fork-Haram

              Services-Halal trades-export-import, Halal trades-smuggling

                 

c)      Difference between Economic consumer and Islamic consumer:

Determinants	Economic consumer	Islamic consumer
Basis	Consumer behavior is based on Economic Rationalism and self interest.	Consumer behavior is based on Economic Rationalism and fear of Allah
source	worldly consumption only	worldly +Heavenly consumption
Halal & Haram	Does not consider Halal & Haram	Strictly consider Halal & Haram
Satisfaction	Satisfaction derived from present and future consumption only	Satisfaction derived from worldly +Heavenly consumption
Limit	No limitation in consumption. such as miser or extravagant	It has limitation in consumption. such as Moderation
Asceticism	Voluntary Asceticism is allowed even below the poverty level	Asceticism may be allowed when consumption has reached the sufficiency threshold.
Hoarding	Hoarding is allowed without limit	Hoarding is allowed for more than 40 days.

d)      Difference between worldly consumption and Heavenly consumption/ consumption for the sake of Allah:

Worldly consumption:

As the part of total consumption which is made by the spender for himself and for his dependants, reward or punishment of which being dependant on his intention (Niyyah).

Source: present and future consumption only + self Satisfaction

            Good intention or Niyyah-Prize

Bad intention or Niyyah-Punishment

Heavenly consumption/ consumption for the sake of Allah/Infaq fi sabilillah:

As the part of total consumption which is made by the spender for the poor and the needy without desiring any reward or even thanks from the recipients either directly or indirectly in this material world. He would of course expect Heavenly benefit or rewards.

Source: present and future consumption only + Heavenly consumption

e)      Want-Utility versus Need-Maslahah

Want-Utility:

Want:

                                                               i.      Want is unlimited

                                                             ii.      Want is the only motivating force of all economic activities.

Utility:

Utility is described as the property of goods and services which satisfy the human want. Any economic activity to produce or acquire something is said to be motivated by the utility of that thing.

Criticized by Islamic economics:

All wants are not equally important

It is not necessary to fulfill all wants

Example: Rice vs. Car,

Both is not equally important even for price of car< price of Rice

Need-Maslahah:

Need:

It is assumed that all human being have some needs instead of wants.

Most important: food-Rice, Wheat, Wear-cloth

Less important: IPS, Refrigerator,

Least important: private car, washing machine

Types of needs:

         i.      Absolute needs

       ii.      Relative needs

Absolute needs:

It originated from within the individual himself and is necessitated by the human condition. Their fulfillment is necessary for human survival, comfort and development.

The Absolute needs are called simply ‘needs’ in Islamic economics.

Relative needs:

It includes all status symbols and all goods and services which are not essential for his well being. The Relative needs are called simply Wants in Islamic economics.

Absolute needs (needs)-Limited

Relative needs (wants)-Unlimited

Maslahah:

Maslahah, rather than utility is the motivating force in Islam.

Maslahah means welfare (worldly +Heavenly)

Conventional economics only consider worldly welfare

Islamic economics consider worldly +Heavenly welfare

Maslahah is the property or power of goods and services that prompts the basic elements of the life of human beings. (Al shatibi)

5 basic elements are life:

                                                                                                         i.      Life

                                                                                                       ii.      Property

                                                                                                      iii.      Faith

                                                                                                     iv.      Intellect

                                                                                                       v.      Property

Maslahah is more appropriate than the traditional concept of utility.

Superiority of Maslahah over utility:

Determinants	Utility	Maslahah
Criterion	Dependents on consumer’s whim. Example: tobacco consumption for Fashion tobacco consumption as food tobacco consumption to stimulate body	Criterion is fixed and Universal. Example: Law: every intoxicant is khamas (harmful) and every khamas is Haram (Muslim) Alcohols is Haram
social norms	it may create conflict with social utility Example: someone has utility from smoking cigarettes while someone has disutility	there is no conflict Example: useful goods and services-allowed harmful goods and services-not allowed
Comparison	Perfect Comparison is not possible. Example: consumer 1-mango  } same amount consumer 2-mango  } What is the level of satisfaction of them?	Perfect Comparison is possible. Example: consumer 1-mango  } same amount consumer 2-mango  } consumer 1-protect life consumer 2-improve health
objective	It does not underline all economic activities in a society. utility maximization- objective of consumption profit maximization- objective of production	It underlines all economic activities in a society. it is the objective underlying production, exchange and consumption

4. Theory of Islamic consumer behavior theory:

Model of Monzer Kahf:

Two important points in Theory of Islamic consumer behavior theory:

1. The consumer values: it is much more important
2. The tools of analysis: neo-classical tools can be used

Three General principles:

Three General principles dominate the economic behavior of human beings in the Islamic culture. These are:

a)      Belief in the last day

b)      Belief in the Islamic concept of success

c)      Belief in the Islamic concept of riches

a)      Belief in the last day:

Believe in the Day of judgments

Believe in the life after death

Consumer concerned with

                                 i.      Outcome of choice is composed of the effects of two life (immediate/here + hereafter life) and their present value.

                               ii.      Alternative uses of income.example-Qard al hasana-free of charge lending, helping the poor and the needy, care for animals

b)      Belief in the Islamic concept of success

                                                         i.      This is nothing but the consent of Allah

                                                       ii.      This is not the accumulation of wealth

                                                      iii.      Spend part of their time and energy for the remembrance of Allah

c)      Belief in the Islamic concept of riches

                                                         i.      Wealth and income (Maal) is a bounty from Allah

                                                       ii.      It must be used for the benefit and satisfaction of human wants and needs

                                                      iii.      It must be used for useful purposes

                                                     iv.      It should not be hoarded

Objective or Goal of consumer or consumption:

Islamic consumer maximizes the consent of Allah or Fallah or success subject to the bounty of Allah i.e. wealth and income (Maal)

Or

Islamic consumer maximizes satisfaction subject to income constraint determined by the level of ‘spendable income’.

Spendable income=total income-planned change in wealth

The Model:

Derivation of Final spending function and graph:

Max U=U (FS, S)

Subject to: FS + S = Y

Where,

U= consumer satisfaction (or utility)

FS = Final spending which comprises spending for the present life and spending for the cause of Allah: this does not yield any income

S =saving= S = Y- FS

Y = spendable income

S=Saving

 FS = Final spending

Figure3: Saving- Final spending relationship

Difference between the Model of Monzer Kahf and the conventional consumer behavior theory:

1. Here the choice is between FS and S and not between commodities (X1.and X2).as in the traditional theory.
2. in the traditional theory, consumer are assumed to spend his/her entire income while in Kahf Model consumer are required to spend and save

Explanation of the Graph:

S -is represented on OY axis

FS -is represented on OX axis

AB-is income level/Budget line

The slope of AB reflects the tradeoff between the current purchasing power and the future purchasing power of one unit of income

Prices are assumed constant

IAIC-Income Allocation Indifference Curve

·        It has negative slope

·        It is convex to the origin

·        Two IC cannot cross each other

Consumer can consume at any point of the IC

P-shows maximum satisfaction, where AB budget line touches the highest IAIC

At P-Marginal Rate of Substitution of S and FS equal to the slope of budget line