Reading 4.

Maghrebi, Nabil, Abbas Mirakhor, and Zamir Iqbal. 2016. “Epistemology of Finance”. In Intermediate
Islamic Finance. 1-45. Singapore: John Wiley & Sons.

The foundations of the economic system on the general rules of justice do not depend on an
accurate precision, but rather the role of morality and ethics in the process of development of social
organization is important.

It is also argued that the rules of morality are also sanctioned by religion before the arrival of the age
of artificial reasoning and philosophy.

Adam Smith seeks to establish the general principles of justice and morality in the economic realm.
Smith tries to make the readers recognise that there is more to life and humanity than economics
and politics. According to Smith, there is four main principle virtues in a person: justice, prudence,
benevolence and self-command. He pays more attention on the last virtue, self-command, which he
defines as the ability to rein one’s impulses, feelings and restrain one’s passion. He argues that it is
through self-command that a person can control his selfish impulses. But, Smith suggests that a
moral economic process is needed in order to develop human passions to reach a higher level of
virtue and morality. Smith emphasises on the role of ethical and moral values such as justice in the
economic system to promote and maximise social benefits and people’s interests.

General equilibrium theory, also called Walrasian general equilibrium, attempts to explain the
functioning of the economy as a whole, rather than as small areas of individual market. As such,
general equilibrium theory is a macroeconomic theory that explains how supply and demand in the
market interact dynamically and eventually reach in an equilibrium of prices in the long run.

The Arrow-Debreu economy is characterized by the existence of a complete set of competitive

markets. The incorporation of uncertainty into the general equilibrium model puts into perspective
the importance of markets for risk sharing and risk allocation. It can be shown that uncertainty does
not affect the equilibrium pricing of risky assets under certain conditions consistent with Arrow-
Debreu economy.

General equilibrium model provides a mathematical framework for optimal risk sharing. It is natural
that attitudes toward risk, including income risk and consumption risk, differ across market
participants. The Arrow-Debreu framework allows for the distribution of risk in the economy among
economic agents according to their respective degrees of risk tolerance.

The framework for an ideal Islamic financial system is inclusive of rules of justice, fairness, conduct
and enforcement, which are derived from the morality and justice system embedded in Islamic
teachings. Islamic economics find its roots in Quran as with any other area of legislation and human
action. It is from the Qur’an that the ideal Islamic financial system can be established, based on the
fundamental rule of the permissibility of al-bay’ exchange and impermissibility of al-riba.