 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

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

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

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

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

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

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

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

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

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

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

Differed Payment; Baia moajal, or Nesia

Assume Price Efficiency

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

O O U U E E Saving Consumer Demanding Consumer

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

Goods or Assets n Nesia rate D S O O

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

An Islamic Investment Model S G I H XW y1y1 y0y0 A A,y 1 y o,I O

n O The Investment Function

Investment and Savings Functions Q n D+I D O n1n1 n2n2 Q1Q1 Q2Q2 Q*Q* I S*S* S n I I*=S O E H K A B KH=AB

(1+n)

= ( n, …,…,

Policy Implementation Financial Policy Stimulating Contractionary Fiscal policy Stimulating Contractionary

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

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