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Source: Mohamed Aslam Haneef, A.H.

M Sadeq, Wan Sulaiman Wan Yusoff and Ataul Huq Pramanik (no date), Principles of Microeconomics from an Islamic Perspective, Department of Economics, IIUM. ECONOMIC SYSTEMS (Chapter 2) Chapter Preview: The global economy has compelled agents to look for alternative economic systems to cope with the new circumstances. At different points of time, different economic systems dominated the global economic trend. So it is essential for you to have grasp on the characteristics and salient features of different economic systems to make yourself an indispensable part of economic dynamism. The second chapter of the book is dedicated for this purpose with the following objectives: (A) To define an economic system and identify its scope. To introduce the student with various economic systems of human society. To laid down the philosophical foundations, operational principles and goals of various economic systems. To identify the common and distinctive features of capitalism, socialism and Islamic economic system. To acquaint the student with the evaluating mechanism of an economic system. Introduction:

In the first chapter we have discussed the general framework of economic reasoning. By applying this economic reasoning every society has to answer some basic questions concerning its economic problems such as, what to produce, how to produce and for whom to produce. To find answers to all above questions, every society has to have an institutional framework, which is broadly known as the economic system of the society. The interaction between societal laws and natural laws in solving economic problems eventually leads society to establish an economic system compatible with the norms, values and worldview of the people. Before we go into discussing the various components of an economic system and the different features of various economic systems, you may ask what is an economic system in the first place? What are the philosophical foundations of an economic system and how does the system work to attain particular economic objectives of the society? This chapter of the book will give you the analytical framework to better understand an economic system and a brief comparative analysis of different economic systems prevailing in the world economic arena. (B) Economic System: Definition and Scope:

Every day you hear about Malaysias economic vision 220. The vision proclaims Malaysia to be a fully developed nation by the year 2020. having a vision means Malaysians know what their goals are and all economic and other governmental policies in Malaysia are aiming towards the attainment of the vision. Same as the Malaysian society as a whole, think about yourself as an individual with your own vision or aim in life. In order to be successful you have to have a specific aim in life. Some of you may want to be a successful businessman, or a politician, or a doctor, or a renowned scholar. All these ambitions will go in vain if you do not organize your life in a systematic way. In other words, you have to be organized and systematic to attain specific goals in your life. Like an individual, different also have different goals ad objectives i.e. economic goals, social goal, and political goals (for example Malaysias vision 2020). To attain all these societal goals and objectives, every society also has to be organized i.e., to have an economic system, social system, and political system. An economic system depicts the organization of a society to attain its economic objectives.

What is a system and how do the various components of the social structure interact with one another and fuse into an economic system to attain economic objectives? Lets look at these in greater detail ----A system is an aggregation or assemblage of objects united by some form of regular interaction or interdependence, a group of diverse units so combined by nature or art as to form an integral whole and to function, operate or move in unison to attain a specific goal and often in obedience to some form of control; an organic or organized whole. (Websters international dictionary) From the above definition, three components of a system are obvious-- A system comprises of different entities and components. All those components interact with one another in an organized way. The outcome of the interaction leads to the fulfillment of certain objectives. From this definition of a system we can easily derive the definition of an economic system. Any aggregation or assemblage of economic institutions that interact with one another according to a particular plan to direct the economic forces of society for the fulfillment of economic goals and objectives is an economic system. An economic system works within the broad framework of a society. As part of the whole social system, an economic system explains the behavior of the economic forces of society. Economic forces depict the reaction of the society to various economic problems. For example, you have a little money to buy books for the semester and you can either buy or borrow from your friend. How do you react to this particular problem of little money and buying books? Malaysian Governments decision is a vital economic force the economy Think about Malaysian society today the economy is may be just coming out recession. In 1998, the economy shrinked almost 6% and there is a possibility that the economy will come back to its normal phase in 1999. In budget 1999 the first prime minister of Malaysia Dr. Mahathir Mohammad declared a deficit budget of RM65.9 billion (RM16.6 billion deficit) to revive the economy by spending more in infrastructure publicly beneficial projects. But it requires a lot of money and the government can either print more money or increase the taxes or borrows money from abroad. If the central bank prints more money it will spur the already high price level and resulting inflation will lessen the impact of a deficit budget. During the recession period it makes little or no sense to increase taxes since business are already in trouble. The only viable option seems to be the last one to borrow money from abroad. Wait!! Dont guess so quickly. There are, also problems for the Malaysian due to certain economic measure taken by the government international rating agencies like Moodys Investor and Standard and Poor (S & P) lowered Malaysias credit worthiness in the international financial market making it more expensive for Malaysia to borrow money from abroad. How did the Malaysian government react to this complex economic situation? What are the implications of each and every alternative financing mechanism? What is impact of the deficit budget during economic recession? Dont worry here is your principles of economics course. In fact, the behavior of economic forces of society is very subjective. Different societies behave in different ways to solve the economic problems and attain their economic goals. Economic objectives also different from society to society. Sometimes even if the stated objectives are the same, their meaning can be different to different societies. Economic forces of society work within two sets of laws i.e. Natural laws and societal laws. Natural laws are same for all societies irrespective of social values, geographical locations and worldview. For example, Diminishing marginal utility, Law of diminishing returns, Law of increasing opportunity cost, Diminishing marginal rate of technical substitution are all

natural laws and exist in every economy. On the other hand, societal laws are shaped by the culture, traditions, history, climate, social norms and values, religion and above all, the worldview of a particular society. For example, the production of prohibited (haram) goods and services that add dis-utility to consumers from an Islamic perspective can be permitted in non-Muslim countries but are prohibited in Muslim countries. Recognizing the fact of different responses towards economic problems and different economic goals, different kinds of economic systems subject to social norms and values are possible and also legitimate. Thus an economic system can be illustrated in the following way -----






What is the status of man in the universe? What is the objective of man in this World? What is the relation of man with other human being?

How are decisions regarding production, consumption and distribution made? How and with what tools does the state intervene in the market? What is the role of the state?

Socio-economic justice, Growth, Development, Efficiency, Stability, Equitable Distribution, Employment Generation

Plans, Strategies and Institutions


It should be noted that two-dimensional diagrams are often inadequate when trying to depict the complexities of social interaction between sub-systems. As you can see in the above diagram, economic system is one of the sub-systems, which stem from the worldview of a particular society. Like any other sub-system, economic system has various components such as philosophical foundation, operational principles, goal and objectives. The following section will give you a brief idea about the various components of an economic system.

Components of Economic System Philosophical Foundations:

The philosophical foundations of an economic system provide the basic for the formation of an economic system. It specifies among the others the nature and status of a human being in this universe as an economic agent, the objectives for human being in related to another and how economic pursuits of man and valued in this context. The philosophical foundation of an economic system recognizes that man as integral part of the system, uses natural resources, accumulates capital, established economic, social and political institutions and activates the economic growth process. The behavior of man and his economic activities has to be within a certain framework subject to social values and norms. Different frameworks will support different economic systems. Operational Principles:

Operational principles imply the manner a system functions. It explains the economic decision making of a society i.e. how does society decide on what to produce, how to produce? What is the mechanism of this decision making related to production, consumption and distribution? How does the state intervene in the decision making of society and what are the instruments of his intervention? Different economic systems answer the above question differently depending on the philosophical foundation of the nature of the operational principles. Goals:

Goals imply the ultimate outcome aimed for of all the decisions made in the economy. Some common goals of all societies are for example, socio-economic justice, growth and stability, fair and equitable distribution, general welfare of the people, fulfillment of basic needs of all the people, efficiency and employment generation. While the goals may seem to be the same, their meaning interpretation and priority may differ from one society and system to another. Some economic goals are complementary and some are possibly conflicting with each other. All these goals and objectives are not independent of the philosophical foundations and operational principles; rather they are natural outcome and consequence of the philosophical foundations and operational principles of an economic system. (C) Different Economic Systems of the World:

Given the perpetual of scarcity in every society, decisions have to be made regarding the allocation of scare resources for production, consumption and distribution purposes. Organization of decision making varies from society to society based on the worldview of a particular society. Thus different kinds of economic system can be adopted by different societies and the past history of human civilization also gives testimony to this fact. It is very easy to identify the philosophical framework of a particular society and differentiate among different economic systems based on them. In the impending section we shall discuss the features and principles of major economic systems of the world i.e. capitalist, socialist and the


Islamic economic system. Comparing economic systems is very important, as it will enable you to better understand how different societies and nations with different economic systems attempt to address the economic problems they face. Comparing Economic System:

There are basically three ways of trying to look at the economic system. The first looks at the system by dividing economics into production, consumption and distribution. The second way looks at the different sectors (agriculture, industry and manufacturing) in the economy and analyses economic activity and decision making in these various sectors. This way is usually found in government reports or case studies of countries. The third way is to look at some common features/categories of comparison across different systems. No matter how different economic systems are, they all have institutions that can be discussed under these features. (a) Characteristics of the economic systems:

This third way of looking into economic systems is the main approach at comparing economic systems. Certain fundamental features of any economic system are analyzed and economic systems are classed based on their features. Usually, the features chosen are features which produce extreme differences between capitalism and socialism since this way of comparing systems was developed in the post world war II ear where capitalism and socialism were comparing with one another. Institution of Property Ownership:

Property ownership is one of the main features in the comparative economic systems approach. Different economic systems depict the institution of poverty ownership in different ways based on the ideology of the system itself. Property ownership is the social and legal relationship of an individual or group with an object. This relationship is depicted by a bundle of rights (and obligations) to tangible and intangible things of value. The nature and extent of property ownership (public Vs private) differentiates one economic system from another. Thus, the institution of property ownership does not emphasis the Thing itself but on the Bundle of Rights (and obligations) that gives individual legitimate right to own, to possess, to control, to dispose and to earn income from that property. Property can be of different types i.e. tangible or real property, intangible property (intellectual property). On the other hand, in terms of ownership property can be explained in categoriesprivates property. Lets look at them briefly.


Real/Tangible Property

Intangible Property

Tangible property has physical existence. It is also called real property. You can get physical services from real property. For example Land, Buildings, your own car, the company car, your computer, the companys computer, capital equipment are all included in real property. You can live in houses or you can produce goods by using capital equipment these are examples of physical services.


Intangible property is a little more complex to define and discuss. Intellectual property is the intangible product of creative efforts. These types of property do not have any physical shape in their actual sense. But they can be expressed in terms of physical existence. For example, the idea of writing a book is in the mind of the writer, you can only know about it once the writer expresses his idea in the form of a book. In the same way, music, computer programs and all kind of new inventions which only originate from the creative expressions of the human intellect are examples of intangible property which are transformed into certain product. Copy right and patent laws protect intellectual property rights.

All these properties can be in two categories Public and Private.

Property Ownership

Public Property

Private Property

Common Property

State Owned Property

Personal Property

Private Property

Private properties are owned by private individuals and private business organizations. Your father owns a house in Kuala Lumpur, so it is a private property. It means that your father has been entitled by the institution of property ownership to control, to maintain, to earn income by renting it out or to live in that house. Private property attributes the bundle of rights (and obligations) to private individuals. Similarly, private individuals own business organizations, which are also private property. However, a distinction is made between private property for personal use and that which are employed for productive purposes. For example, you own a computer, so it is your personal property. But when personal properties re employed into income earning activities than they are called private property. If you open a computer-training center at your house and use you own computer, then it is no longer personal but private property. Or in the previous example, when your father rents the house then it termed as income earning private property. The distinguishing feature is whether the use is for personal reasons or for the production purposes. If the bundle of Rights (and obligations) concerning a particular object is attributed to the common public or the state, it is known as Public property. The access to and control of public property is determined directly by reference to public interest. These are two main categories of public property-State owned or Common property. o State owned property is controlled and managed by the state. The State has complete rights and makes decision on the use based on public interest even if it means giving it to the private sector to manage. For example, in Malaysia, the government owns certain resources such as land and roads but the privatization process of highway projects is an example to show how the state makes this decision. However, this is still done in the name of public interest.


On the other hand, common property belongs to all people and everyone in the society has equal access to that property. The state or any other private organization can assume the management responsibility of common public property but everyone is to have equal access to the property. Public Parks and the sea are examples of common property.

The institution of property ownership is one of the basic elements analyzed in the comparative economic systems approach. Different kinds of economic systems are based on different foundations of property ownership. Motivational Factor: Material Vs Moral

The nature of interaction among the economic institutions in an economic system differs from society to society based on the values, norms and ideological framework of that society. Human beings are naturally created inquisitive. The needs of the body, mind and spirit make human beings strive to constantly acquire what is necessary to meet these needs. This diverse behavior is a resulting factor or consequence of diverse motivating factors in different economic systems. Human beings are born with a natural inclination to achieve success. Why do you study? Why dont you quit your study and get a job somewhere so that you can earn an income? There is certainly a strong motivating factor that is stopping you from leaving the university. Similarly, the choice of an economic system of the society depends on the compatibility of the motivating factor of a certain system and the worldview of the society. Certain system stresses personal material gain whereas others stress public duty and moral as the motivational factors.




Organization of Decision Making: Decentralized Vs Centralized

Planning, organization and allocation of scare economic resources are necessary for efficiency in the production, consumption and distribution processes. Given limited economic resources, every economy must decide what to produce, how to produce, how must to produce, where to produce and for whom to produce? This decision has to be made before the production, consumption and distribution of a product takes place. But how or at which level are decisions made in different economic systems? The governing role of for decision making in different economic systems can be derived from the philosophical foundations and worldview of the economic system itself. The organization of decision making can either be centralized or decentralized. In centralized decision-making, a central authority makes the important decisions of economic activity regarding production, consumption and distribution. Delegation of power regarding decision-making is very rare in a centralized system. High level or the Central authority dominates the decision-making just like a dictator makes all the decisions regarding the management of a whole country. In a decentralized system, the organization of decision making is theoretically decentralized to the lower levels. Individuals or private business organizations are the main agents of the economic activity of the country. In fact, in a decentralized system, the decisions concerning production are determined by the business sector while consumption is determined by the household sector, and the distribution is determined by the assumed smooth functioning of the built in mechanism in the product and factor markets. Given the fact of the current global economy, where multinational


corporations are moving all over the world for new markets ignoring national boundaries, centralized decision-making has been said to be inefficient. Since American based companies operating in Malaysia cannot operate efficiently if all the decision are made in American and implemented in Malaysia, for many economists and business corporations decentralized decision-making is the way to go. Coordination mechanism: Market Vs Plan

In the above discussion we were talking about the motivation, decision making process in different economic systems and their implications in the practical world. But a central question still remains. How do all these factors relate to each other? How are all the decisions regarding production, consumption and distribution coordinated and implemented in the economy? The coordination mechanism of the society is another characteristic of economic systems that can be analyzed for comparative purpose. Certain economic systems give large freedom to individual economic agents and institutions of the society to interact with one another through the market to solve all the decisions made regarding production, consumption and distribution. Whereas other economic systems do not give any independence to the economic agents and institutions to interact, rather a central plan coordinates the decisions through the levels of society. (b) Production, Consumption and Distribution:

All economic systems have to solve the problems of production, consumption and distribution in the economy. Given the fact that resources are scare compared to the uses they can be put to, an economy has to decide what to produce and how to allocate the scare resources to produce the desired goods and services. Society has to decide whether the production of certain goods adds to the total utility or creates dis-utility to the society or are neutral in effect. The concept of utility is also value loaded and differs from society, to society. For example, consumption of alcohol and pork may add to the utility of a non-Muslim society i.e. China and U.S., but is a disutility to a Muslim society because the consumption of alcohol and pork is forbidden in Islam. So in an Islamic economic system the production of alcohol and pork is not permitted for Muslims. On the other hand, consumption of injurious drugs like heroine, cocaine is harmful for health and therefore, production is forbidden in all economic systems. The consumption behavior of the society also differs from one economic system to another. Whereas, in an Islamic economic system, success in this world and in the hereafter is aimed for, capitalism only gives value to current consumption. A moderate rather than a luxurious lifestyle is strongly encouraged in an Islamic economic system. While in Socialism equality of utility or consumption of public good is more stressed. Distribution of income and output is also guided by the philosophy of a particular economic system. For example, in mainstream neoclassical market capitalism, the distribution of income and output is determined by the productivity of the factors of production (land, labor, capital and entrepreneur) and depends completely on market forces, representing justice to them. No inherent conscious consideration is given to those who are by passed from the process of development. While, in an Islamic economic system justice takes a different meaning, where productivity in distributing income and output is couple with optional and compulsory transfer payments to take care of the people who are by passed from market distributive measures. In socialism everyone in the society is provided only with basic needs. Latter on in the subsequent chapter, we take a closer look at production, consumption and distribution. (c) Sectors in the Economy:

There are different sectors in the economy. Classical structural theory of economic development concludes that the dominance of certain sectors in the economy depicts the level of economic development and economic maturity of a society. The sectoral analysis of an economic system is generally used government reports to analyze the stage and level of economic development and


to formulate specific plans for development. Traditionally, an economy is composed of three sectors i.e. primary (agriculture), secondary or industrial (including manufacturing) and tertiary (services). The dominance of a certain sector in the economy depict the level of economic maturity, diversity of production and development. A country whose economy is based on agriculture is generally considered to be an under developed economy. As the economy grows, the dominance of the agricultural sector ends and the industrial sector starts growing very fast increasing levels of income and higher standard of the people. At higher stages of economic development, when sustainable economic growth has become a normal long-term trend, the service sector becomes predominant in the economy. Given the different stages of economic development and sectors in the economy, the decisions about production, consumption and distribution have to be compatible with the level of economic development in the economy. For example, if an agriculture-based economy with low levels of income decides to produce all luxuries goods and services, it cannot co-ordinate properly among the production, consumption and distribution process. This will be due to the fact that the production of luxurious goods and services are not compatible with the low-income level of the people. In fact this is one of the problems existing in many developing countries. The credibility of an economic system depends on how precisely and meticulously it can coordinate the decisions of production, consumption and distribution within a specific level of economic development. (C.1) Major Economic System:

Since the inception of human civilization different economic systems dominated the global economic. Every economic system is different given its different philosophical foundation, operational principles and goals. The following section will introduce you with major economic systems of the world and their salient features. (a) Capitalism and its salient features:

There is no universal definition of capitalism. In ideal form, it is an economic order based on private ownership of resources and free and fair operation of the market mechanism. The system is based on the idea that large amounts of capital will not be available for the use of production unless there is a secure process of saving and capital formation and that an elite capitalist class of the society leads this process to accelerate economic development. This historical inception of present-day capitalism goes back to the middle ages, where the search for profit was the dominant motive in the lives of many, especially the merchants of the Italian city-states of Genoa and Venice. The decline in the authority of the church in state affairs and the gradual secularization process saw the acceptance of the concept of profit in part because they, too, found good use for money. Finally, the industrial revolution in Europe in the th 16 century created an industrial capitalist class who took over their predecessors (mercantilists) and shaped the course of future industrialization by reinvesting their gains in new enterprises. The industrial revolution also enormously accentuated the movement towards international economic interdependence and capitalism became the predominant economic order of the world. The features of capitalism are given below-- (1) Common features of capitalism: Institution of Property ownership: Under Capitalism, property is owned by private individuals and private institutions rather than by the State The Capitalist economic system also gives private individuals and business organizations substantial autonomy to negotiate binding legal contracts to control possess, dispose and obtain any kind of property, regardless man made or natural resources. The basic assumption behind this private property ownership is to encourage capital accumulation and to accelerate the


growth process. Private property ownership in capitalism is also subject to some broad limitations posed by the State or certain framework of laws and culture of the society. If someone uses his privately owned resources for the production of illegal drugs, it will be detrimental to the society. In this case the ownership has to be restricted. Public property is also in existence in capitalism. For example, public ownership of natural monopolies is also found in capitalist systems for the efficiency use of certain resources and public interest such as railway tracks, electricity generation generation and telecommunication. (2) Institution of Property ownership: In capitalism, the motivating factor reflects the concern for material wellbeing of the people. Material self-interest of the individual is the main driving force behind capitalist ideology. Every economic agent in the economy attempts to do what is best for himself and in doing so is assumed to maximize the wealth of individuals and the society. The business firm in a capitalist system wants to maximize profit and minimize cost. While the concept of self-interest is not similar to selfishness, one could argue that the distinction between the two has slowly but surely been eroded over the years. When all individuals of the society maximize his or her selfinterest, the wealth of the society will be maximized. As Adam Smith puts forward in his remarkable book The Wealth of Nations--It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner but from their regard to their own interest (3) Organization of decision making: Theoretically, in a market economy, business sectors have the freedom to obtain any resources in the economy they want and produce any product they think marketable i.e. products that are demanded but their activity is limited to the decision-making or demand of the consumer. In reality however, the market economy is increasingly being controlled by few powerful business organizations and they can easily influence the decision-making of the consumer through advertising. Albeit philosophically, capitalism provides independence to both consumer and producer. Ironically, the whole system has moved in such a way that decision making about the economic problems of the nation are captured in the hands of a few powerful business organizations. Coordination mechanism: The basic coordination mechanism in capitalism is the market or the price system. In other words, capitalism is basically a market-based system. The decision rendered by buyers and sellers regarding production consumption and allocation of resources are made effective through a market system. The economic agents and institutions of the society theoretically enjoy full independence in their interaction with each other. The lubricant of this interaction is the price system. The interaction of the market forces lead to the price or value for a certain product agreed by both the demander and the supplier. For example, in a market you can buy anything at negotiated prices, which is acceptable to you and the seller. Or in stock exchange, you could buy and sell any stock at a negotiated price without any extraneous intervention. The recent restriction imposed by the Malaysian government on selling of stock aims to intervene in the market to curb the freedom of certain market players for national economic security.



Resource cost

income Coordination mechanism through market
factors of production

Goods and services



Goods and services

Figure: Coordination mechanism in a market economy

As you can see in the above diagram, capitalism divides the economy into sectors such as product market and resources market. Households and businesses interact. Households supply factors of production in the resources market and in return they get income. On the other hand, businesses buy resources from the resource market in return of payment for the production of goods and services. Then in the product market businesses sell their products to the households and get revenue. When the circle complete, the whole process starts again with the resource market and continues. The price system in the economy acts as a lubricant to the process and smoothen it further. (1) Distinctive features of capitalism: Philosophical foundation:- Individuals effort towards maximizing self-interest provides the basis for capitalism. This particular economic doctrine assumes that human beings are naturally and inherently inclined towards worldly achievement and the main source of economic progress is accumulated capital. So maximization of material well being is the main concern of the capitalist economic system. Philosophical foundation:- Under capitalism property resources are owned by private individuals or private business organizations. Private individuals or businesses can obtain, own, control or dispose of any resources they want. The ownership and use of private resources have to be within the legal framework of a particular country. No one can use his or her resources in any way that is harmful for the society as defined by their own laws. Freedom of enterprise and choices:- It is closely related to the private ownership of resources. Under pure capitalism, private business enterprises are free to obtain economic resources in the production of goods and services of the firms own choosing, and then sell it in the market of their own choice. No extraneous obstacle other than market competition creates impediments for an enterprise to enter or leave a particular industry. Under capitalism consumers are also free to choose any product of their choice. Thus the freedom of business enterprises to produce any kind of product they like is limited to consumer choices, as consumers are the ones who buy the goods and services produced by the businesses. Consumer sovereignty is said to be the rule in a capitalist economy (especially according to the neoclassical proponents of capitalism). Profit motive: The decision of business enterprises in a capitalist economy is primarily motivated by monetary profit. The business sector is directly responsible for concerting





the productive resources into real goods and services and determining what these products will be, guided by the actions of the consumers in the market place. The profit motive is the locomotive that draws managers to produce goods that can be sold at prices that are higher than the cost of production. Maximize the profit is the cornerstone of decision-making by business firms in capitalism. (5) Role of self-interest: The primary driving force of capitalism is the promotion of ones self interest; each economic unit attempts to do what is best for itself. Driven by selfinterest, individual business enterprises primary concern is to maximize profit and maximize cost; public corporations aim to maximize the welfare of its shareholders and individual consumers maximize their utility. The concept of self-interest should not be confused with selfishness. In fact, in capitalism, self-interest is the way towards maximizing the welfare of the whole society, albeit, unconsciously, and unintentionally. Competition: Freedom of enterprise, self-interest and the profit motive enhance competition in the market among enterprises. In the ideal from of markets, large number of business firms competes with one another in the market place without any legal or other barrier to enter into and exit from the market. Free entry and exit in the operation of the market creates a very competitive environment in the market place. Competition as a general, increases efficiency. Markets and the price system: The basic coordination mechanism of all the decisions made under market capitalism is the market or the price system. A market is the place where the buyers and sellers of a commodity come together and negotiate the value of a certain product produced by a business or household. Price is the basic organizing force of interaction in the market system. Price reflects the value consumers want to pay for a particular product expressed in terms of money. The interaction of demand and supply mechanism determines the price of a certain product.



Price Y Supply

P2 P1 D1 0 Q1 Q2 D2 X Quantity per time

Price determined by the market


Limited role of the government: In laissez-faire capitalism, the role of the government is limited to providing stable social, political and legal framework in which the market operates efficiently and to promote competition among the business firms. The selfadjusting and self-regulating notion of laissez-faire capitalism provides little scope for the government to intervene in the operation of market.


--Think for a While In October 1989 with the fall of Berlin wall, the reign of capitalism started over the global economy. Today, the former Soviet Union longer play a dominant rules in the global economy. Russia and its 26 east European satellite states are in the transition from socialism to capitalism. Russia the birthplace of social is presently in the deepest economic and political crisis it has ever been. The triumph of capital ideology is now being considered by some western intellectual as signifying the end of history and man in the liberal capitalist society is considered to be the last man. But whats the real economic picture of the world economy. ---- The world economy has grown six fold and the production of goods and services went from less than U.S. $5 trillion to over U.S. $30 trillion between 1950 and 1997. But why do 1.3 billion human beings live under absolute poverty? Why do the receive less than U.S. $1 a day per capita when there are those who receive over $1 million a day? Why do 800 million people lack the most elementary health services? Why do the developed countries with only 14.6% of the total population of the world (4.815 billion) consumers only 18%. .What is the price of human life? World population is growing at a rate of 80 million per year and almost 7 million in total in the last 100 years our population has reached its second billion, but the last billion were born in 11 years. In 50 years there will be 4 billion new residents in the world. Who will feed them? How will we provide them the basic necessities? Is something wrong with the current economic system of the world? Are we having the right economic order or do we have to revise the way we used to do our economic activity or do we have to find alternative economic order? (b) Socialism and its salient features: In theory, socialism is a socio-economic system that tries to reorganize the whole society in such a way that every one will contribute what they can, and get what they need. The foundation of socialism can be found since the civilization began but the present day socialism was put forward by a German born philosopher Karl Marx. In many aspects it th th was a reaction to capitalism of the 17 and 18 century. The industrial revolution in Europe created two classes in the society. One was the modern industrial capitalist class and another was the Proletariat or working class. The incipient exploitation of the capitalist class motivated Marx to write his famous book Das Kapital. Marx found a zerosum game in the capitalist system. The capital accumulation of the capitalist is at the expense of the working class. He argued that the capitalist economic system is a static phenomenon. It does not explain the dynamism of social evaluation. Socialism, in Marks ideology is supposed to be the final stage of historical development. The proletariat class will bring social revolution and establish a new economic order based on the already accumulated capital of the capitalist. The revolution in the former Soviet Union in 1917 was a product of Marx ideology. Other countries likeNorth Korea, Cuba, and to a great extent China are now following a socialist economic order (although China is now making some market reform). The main features of Socialism are as follows--- Common features of socialism:

(1) Institution of property ownership: In socialism, the opposite extreme of capitalism is the norm. In socialism, the state owns all factors of production in the economy. Private ownership of resources is not allowed. The ideology of socialism is based on the idea that the institution of private ownership is the main source of class struggle (capitalist vs. worker) in a capitalist system. The solution proposed by the socialist is to bring a social revolution and abolish the institution of private ownership and establish state ownership of resources in order to activate the development process on equal sharing of income and resources. (2) Motivational mechanism: In terms of motivation, socialism delineates the opposite extreme of capitalism. It says that individuals good do not lie within their own self-


interest and action. The concept of self-interest will doom the welfare of society as a whole; moreover it is a source of class struggle and social evil. The collective interest of the society should get ultimate priority in a socialist economy. Therefore, public interest is the motivating factor put forward in a socialist system. But the recent down fall of socialist states has proven the lack of realism in that price basic assumption of socialism. The unnatural suppression of the basic acquisitive instinct of human beings has proven the failure of this aspect of socialism. (3) Organization of decision making: The gradual mechanism of accumulating power by the elite class in the market economy has posed a conundrum about the validity of the system. And as a resulting factor, the rise of socialist ideology in different parts of the world threatened the existence of capitalism. In socialist economic systems, all the decisions regarding production, consumption and distribution are made by the authority or the state. In some form of socialism/communism the existence of intermediate business sectors has been obliterated. By eliminating the elite business class and providing an equal platform for all the people in the economy through centrally made decisions, socialism tries to give socio-economic justice to all the people in the society. As above three seems to be lack of realism in the way socialist countries have tended to organize themselves. (4) Coordination mechanism: While capitalism gives full independence to market forces, the socialist ideology restrict the independence of the economic agents and centralizes the economic decision making to the state. The discussions are then conveyed through a planning mechanism. It is the State in a socialist economy that decides what to produce, how to produce, how much to produce and for whom to produce. The state also determines the price rather giving the price mechanism independence to allocate the economic products and outcomes. Price is ten communicated to the society via a plan or instructions from the state. Distinctive features of socialism Philosophical foundation: Socialism considers individualism as the source of social evil and exploitation. Collectivism rather than individualism according to them can be the basis of a better society. The theoretical foundation of socialism assumes that there already exists a capitalist class who has accumulated vast amount of wealth through the exploitation of the working class. The dissatisfaction of the working class will beget revolt so as dramatic social change. (2) State ownership of resources: In socialism most properties are owned by the state, Socialist believes that the institution of private property in capitalism is the primary source of evil in the system. Private ownership of resources eventually creates a huge social gap between those utilize these properties in productive manner (capitalist) and those who are by-passed from the flow of development (working class). Socialist believe that state ownership of resources will preclude wealth discrepancy and eventually formed a just society where every one shares the equal rights and obligations. Concentration of power in the socialist party: Socialism is the single economic system that linked economics with politics quite substantially. In socialism, the socialist party is supposed to represent the working class. It is the sole proprietor of political power and is involved in all phases of economic activity. Cooperation: Individualism, which is one of the basic institutions of capitalism, is replaced by cooperation. The idea of individualism fosters acquisitive ambition, which sometimes ignores the interest of the society. Opposite to that we have the idea of collectivism. Collectivism and hence Cooperation, is supposed to lead to the development of a perfect society.




Islamic economic system and its main features: Islam is a complete code of life. The economic affairs of our daily activities are not an exception from this code of life provided by Islam. So an economic system guided by Islamic principles is also possible. We have discussed abut the existence of different economic systems based on different societal frameworks and worldviews. An Islamic economic system also stems from the Islamic worldview. While the main governing principles of an Islamic economic system are the same, irrespective of societies, different kinds of Islamic economic systems may also exists in different Muslim societies based on the socio-political, cultural, traditional, and historical differences of various societies. God, according to the Islamic worldview, has created the universe for the benefit of human beings. God has made the resources of this earth available to man who has the responsibility to use them in most efficient ways and transform them into goods and services according to his needs to attain falah or ultimate happiness. All human economic activities have to be within the boundary of the Shariah. The main features of an Islamic economic system are as follows

Common features of Islamic economic system: Institution of property ownership: The discussion about property ownership in capitalism and socialism is from a theoretical perspective. In real life, capitalist and socialist systems have a mixture of both public and private property. What differentiates between a capitalist and a socialist system (and the variation within capitalism) is the degree of mixture between public and private property. In the 1960s, capitalist states of the world introduced welfare reforms incorporating some features of socialism and during the 1980s, socialist states have moved in the direction of capitalism. This is why in real life you can find different countries ranging adopting Stalinism, market Socialism, State Capitalism and Market capitalism, depicting varying shades of public to private property being the norm. In an Islamic economic system, the governing role of the institution of property ownership can be derived from the philosophical foundations of the system itself. Islam says that God, the sustainer of the world has created every thing in this universe for the benefit of human beings. So, He is the absolute owner of all the resources in this world. Man, as the servant of God, is only the trustee of all these resources. The ownership of man in an Islamic framework is relative. Man can privately own, control, dispose the property, but at the same time has to assume the responsibility as trustee of these resources, to utilize these resources in the best possible ways and in accordance with the Islamic shariah. Private ownership of resources in an Islamic economic system is also limited by the interest of society. Public interest is one of the basic objectives of Shariah. Public ownership is allowed in Islam for natural resources and in those cases where private ownership may be harmful for the interest of the common people. For example, the private ownership of sources of drinking water and power (electricity) may some time lead to abuse, so all these properties should normally be publicly owned. The important distinction in the Islamic system is that even theoretically; both private and public properties are acknowledged.


Motivational mechanism: The motivating factor in Islam stems from the Islamic worldview. Motivation in an Islamic economic system delineates a real balance between the material and spiritual wellbeing of human beings. Thus an Islamic economic system extends the horizon of motivation from the visible and material to the invisible and spiritual in the hereafter. The Islamic worldview recognizes the existence of the hereafter and provides the motivating principle keeping in view that the welfare of both worlds will be maximized, known as Falah or ultimate happiness. Economic actions and other


activities of man in line with the Shariah will determine his reward in the hereafter. In fact, economic activities become worship in Islam if done correctly and with correct institutions. Islam recognizes the self-interest of the individual but limits it within the circumference of the Islamic framework. When the self-interest of individuals create impediments to the welfare in the hereafter or to the society, then this simplistic notion of self-interest has to be abandoned and replaced by a more complex notion of selfinterest which also incorporates the interest of society and happiness in the hereafter. (3) Organization of decision making: An Islamic system talks about Shura concerning the organization of decision making. A Shura is the supreme body of decision making in an Islamic state composed of selected qualified individuals from the society. The decision making of Shura is not necessarily equal to democracy as understood in the usual western sense. Islam always emphasizes on the truth and just decisions, not merely on the number of votes per se. In an Islamic economic system, preference is given to market forces. But the market does not necessarily reflect the welfare of the society all the time. Whenever any imperfection occurs in the market, the state has an obligation to intervene in the market and correct the imperfections. There is also a specified role for the state in an Islamic economy. This is specially related in terms of regulations and control if necessary, to fulfill the basic necessities of the people and curb manipulation in the market by business firms. In this way the Islamic economic system recognizes that individual decision making has to be bounded by the framework of the Shariah. Therefore, while decentralization is favored, certain outlines and parameters could be centralized. Coordination mechanism: Although in theory different coordination mechanisms exist in different economic systems, the real world coordination mechanism is a combination of market forces and planning. The market enjoys substantial independence but when it fails to reflect the correct signals to the market players because of market imperfections, the state can intervene in the market to correct the distorted signals and thus plays a major role in the market. In some societies, the State plays an even more significant role in the economic affairs. The State has specific policies regarding the economic goals of the nation and can formulate plans and let the market operate with in the planned framework made by the state. This particular system is know as Indicative Planning where the state identifies the areas for development and provides certain incentives and let the market forces behave with its own rational. The birthplace of Indicative Planning is France; Malaysia is also a good example for indicative planning. The state can also provide a stable social and political environment for the market to operate smoothly.



Figure: The legitimate effective role of government in market Mechanism


In an Islamic economic system, the concept of coordination mechanism is again derived from the Islamic worldview which recognizes the existence of the hereafter and all economic actions of man have to be aimed towards both worlds, here and hereafter. The coordination mechanism relating to decision made about production, consumption and distribution should reflect human welfare in both worlds. Given the Islamic values and norms already existent in the market, the Islamic economic system gives market forces relative independence subject to the Islamic rules of the game. The Islamic State has an effective role to play in the market mechanism. The market system does not always reflect the welfare of society aimed at both this world and the next. Here the Islamic State has to intervene in the market and correct the distortions in the market and direct the operation of the market according to the Islamic rules of the game. The Institution of al-Hisba is a distinctive future of an Islamic economic system. The institution of alHisba ensures that right kinds of products are being produced in the economy; sellers are giving right measurement to the buyer as well as there is no fraud and cheating in the market. It also regulates municipal services, settles petty disputes among the market players and finally paves the way towards a free and fair market. In todays world, rather than look for one institution to play all the roles of al-Hisba it is possible that the functions of al-Hisba are undertaken by different bodies and organizations since societies have become very complex. The important distinction here is that while the market mechanism is preferred, it is not sacrosanct. The state, via planning can guide, regulate, and intervene for welfare of the society as a whole. (1) Distinctive features of an Islamic economic system: Philosophical foundation: The philosophical foundation of an Islamic economic system originates from God, the creator of human beings and universe. In an Islamic economic system, human beings as the servant of One God, use scarce economic resources in the best possible ways to maximize the material and non-material well being in this world and the world hereafter. Nature of man and his function: Conventional economic systems (especially capitalism) assume man to be inherently selfish. In capitalism, self-interest is considered to be the way of maximizing the welfare of the whole society. According to the Islamic worldview, human beings are created as servants of God and vicegerent or earth. God entrusted them with His resources and asks them to extract their benefits from the resources created by Him. So, man is allowed to satisfy his individual needs but his selfinterest has to be within the limit of Shariah. Islamic rules of the game are the controlling mechanism of mans self-interest. An Islamic economic system propagates that every one can, and should, contribute to create a better Islamic society. In short, man has to consider not only himself but others as well. Extended time horizon: An Islamic economic system does not limit the outcomes of economic activities only within this material world. The Islamic worldview recognizes the existence of the hereafter. So all human economic activities should aim at both this world and the world after. In fact, economic activities in line with the principles of Shariah will work towards the welfare in both worlds. Relative ownership of property: According to the Islamic worldview, God has created everything in this world, so He is the absolute owner of all these resources. God has entrusted man with all the resources for their own benefit. This concept of trust also implies human responsibility and obligations in the use of all these resources. Man can own property but not absolutely. Private ownership is acceptable but as a relative owner of resources, man has to perform certain obligations prescribed by Shariah in the use of economic resources. Public property is also a legitimate form of ownership. The concept of Shura: Decision making in an Islamic economic system occur through the concept of Shura or mutual consensus. While Islam gives preference to the market, markets may not always reflect the welfare of the society all the time. When any






imperfection occurs in the market, the state has an obligation to intervene and correct the distorted market signals. What kind of intervention is decided through mutual consultation or Shura. The Majlis shura comprises selected individuals among the people of the society based on their qualities and character. The decision making of the Majlis shura is based on truth and justice. (6) Institution of al-Hisba: This acts as a regulatory body in the market. The institution of al-Hisba ensures that the interactions among different institutions in the market are according to the Islamic rules of the game. It supervises the activities of different market participants. The institution of al-Hisba has its roots in the early days of Islam, when the Muslim States established separate institutions to supervise markets, to provide municipal service, and to settle petty disputes among the market players. The person who administers the institution of al-Hisba is known as Muhtasib. In todays world the role of Al-Hisba to some extent has been replaced by numerous separate organizations such as the Ministry of police force Industrial court or consumer affairs e.t.c. in many Muslim countries. Institution of Zakah: Another distinctive feature of an Islamic economic system is the institution of Zakah. Zakah is an obligatory financial levy on all surplus wealth of Muslims. Zakah is a charge in varying rates and can be allocated by the Islamic State. The Islamic State can force the individual to pay Zakah if the person has been found to be eligible to pay Zakah. The main objective of Zakah is to transfer surplus wealth from the rich to the poor. Thus Islam provides a built in mechanism of distribution of wealth. The Institution of Zakah can be a major instrument for providing social security, to alleviate poverty and to reduce income disparity. The institution of Zakah existed in all the Muslim societies through out Muslim history and still exists today, albeit less prominent. Many scholars also see zakah as the pillar of a countrys fiscal policy. Prohibition of Riba: An Islamic economic system is completely riba free. In capitalism, capitalism, capital movement has been entrusted with financial market and the entire operations of the financial market are based on interest (unearned gain). Payment of interest leads to injustice and bread exploitation, which is forbidden in Islam. Table A Answer to the central economic question by major economic systems: Central Economic Question What to produce? Capitalisms Answer What business firms believe people want and firms will make profit Socialisms Answer What central planners believe socially beneficial Islamic Economic What is permissible in Islamic shariah and needed. No extravagance is allowed. Producer decides how to produce efficiently keeping view their profit motive. Every one in the society is provided with the basic necessities by the Islamic state.



How to produce?

Producer decides how to produce efficiently keeping in view their desire to make profit Distribution according to ability and inherited wealth

For whom to produce?

Central planners decide keeping in view the greater benefits of the society. Distribution according to individual need determined by the central planners.


Table B Comparing salient features of different economic systems Salient features Institution of property ownership Motivational factor Capitalism Private property Socialism State property owned Islamic Economic System Both private and public property are acknowledged Attain falah in this world and in hereafter. Market mechanism with a positive role of the state Market mechanism with a positive role of the state.

Material gain in this world

Collective welfare of the society Central planning

Organization of decision making Coordination mechanism

Market mechanism

Market mechanism

Central planning

Summary: An economic system is a complex mechanism, which facilitate the interaction among various economic agents in order to pursue the economic objectives of individual as well as the society. An economic system operates within the broad framework of a social system. Thus, besides natural economic laws i.e. law of diminishing law of increasing opportunity costs; various social laws dictate the activities of economic agents within a certain socio-political set up. The governing principles of an economic system stem from the worldview of a particular society. The philosophical foundation, operational principles and goals and objectives of an economic system this has to be compatible with the worldview of the particular society. Because of differences in worldview different economic systems with different set of philosophical foundations, operational principles and goals and objectives are possible and also legitimate. Different economic doctrines dominated the world at different points of time such as feudalism, mercantilism, capitalism, socialism and recently the resurgence of Islamic economic system. No matter how different an economic system is it has to explain production, consumption and distributive factor organization of decision making and coordination mechanism are the most common features of any economic system. Individual economic systems have their own distinctive features. While pure capitalism gives individual economic agents substantial amount of freedom and favors the capitalist class of the society socialism is created on the weaknesses of capitalism and favors working class of the society. On the other hand an Islamic economic system propounds for a balanced society by ascertaining basic necessities for each and every individual in the society while allowing for the legitimate earning and accumulation of wealth.


ANSWERS TO SELECTED QUESTIONS ON ISLAMIC ECONOMIC SYSTEM Explain the maqasid shariah Maqasid al-shariah: Maqasid al-shariah means objectives of shariah. The objective of shariah is to protect public interest (maslaha). Maslaha is the criteria for all decision making from individual (Micro) to societal (Macro) and international to global levels. Maslaha aims at seeking something useful (manafah) or removing something harmful (madarrah). The criteria or maslaha (public interest) are applied to preserve or achieve the maqasid al-shariah. The maqasid al shariah consist of following five things: Religion, Life, Reason, Descendants, and Property. 1. Religion: The protection of religion is one of the basic objectives of shariah. In an Islamic country every person is free to perform his or her religious activity. So Islam makes sure that people have freedom of religion, and respects each others religions, freedom and places of worship are also protected and respected. Life: Another purpose of shariah is protection of life. It can be trees, animals or human beings. Anything that can harm any life in any way is not allowed by shariah. Shariah is very careful to protect life. For example during the Prophet Muhammads (SWA) time, in the war field (jihad) nobody was allowed to destroy crops, trees, women, children, and those who were not involved in war. This is because shariah gives the guarantee of protection of life. Reason: Reason means Intellect (aql). Shariah does not allow to do to have anything that may harm our senses, for example alcohol. Alcohol affects our reason and senses negatively that is why shariah does not allow alcohol. Descendants: Descendants refer to future generations. One of the important objectives of shariah is to preserve out future generations. We are not allowed to do anything that can be a threat to our future generations. For example we can not destroy trees because it has far reaching effects on future environment as it would threaten the healthy existence and survival of our future generations. Another example is marriage, to preserve future generations shariah strongly encourages marriage between man and woman and at the same time considers homosexuality as a sin commitments to a healthy and successful future of humanity Shariah regards proper upbringing and education of children as the duty of parents for which they are accountable on the Day of Judgment. Property: Shariah prohibits to damage or destroy or waste or any extravag of resources. Because the real owner of the resources is Allah (swa), we are only trustee of this property. To use the property for fulfilling our unlimited wants shariah has three stages. They are (a) daruriyyah (necessities), (b) hajiyyat (requirements), (c) tahsiniyyat (beautification). Property should be used first for the necessity goods then requirements after that beautification.





The main purpose of shariah is to preserve the above five things for our societys welfare. Explain why we need maqasid al shariah in a market economy? Market economy has some limitations or disadvantages. Sometimes these limitations deprive some people even of their basic needs for example food, clothing, shelter, etc. To remove such types of problems we need maqasid al shariah. The needs of maqasid al shariah arise for number of reasons for examples: 1. Market economy produces only for whom those are able and willing to buy. But some people are to be able to buy their needs. Market economy does not care about them but


maqasid al shariah is committed to the preservation of human life and dignity. So due to this commitment the government in an Islamic state will help the poor and the needy to ensure fulfillment of basic needs al those who can not afford the basic needs. 2. Market economy aims at profit maximization. It does not care about the interest of the society. Market economy will accept alcohol production and casinos gambling etc, if these business are profitable. But maqasid al shariah committed to public interest. So, due to this negative impact on public interest such economic activities will not be allowed in Islamic society. Maqasid al shariah does not allow any waste of resources and properties. So it ensures the most production efficiency while in market economy depends on producer. In the market economy, sometimes necessary goods can be denied by the producer because of less profit and people will get difficulty to meet their basic needs. But maqasid al shariah ensures first necessity goods then other goods for example education, health care etc. Market economy motivated by profit maximization and allows economic activities that may negative affect on future generation for example violation in film and TV, glorification of sexual freedom, pornographic materials, etc. But these things have negative effect on children and youth and lead to their moral decay and diseases for example crime, drugs, HIV & AIDS, break down families etc. hence an Islamic society guided by maqasid al shariah will prohibit all this things. Although market economy, driven by profit motive, allows it. For the reason of protecting and promoting public interest maqasid al shariah are needed to guide market economy.




So we can say that market economy has some limitations and maqasid al shariah is perfect to remove these limitations. To remove the limitations of market economy any also for people welfare we need maqasid al shariah in the market economy.

Differentiate Features of Islamic Economic, Socialist and Capitalist System The ideologies of capitalism and socialism though differ in approaches, are both rooted in materialism whereas Islamic economic system is rooted in morality of socioeconomic justice grounded in Maqasid-al Shariah with the focus on public interest. The major features of these three economic systems are as follows: CAPITALISM: Private Property-Gives every individual the right to own resources, acquire goods and services and to dispose them according to their wishes. Self Interest-The major motive of production is self interest under this system. Every individual pursues his self interest, so as to maximize satisfaction and profit and minimize the costs. Absence of Planning-There are no central plans. Economy operates as a result of the individual decisions based on demand supply, made by millions of economic units. Free Occupation-Every individual is mobile free to choose his/her job Competition-It encourages initiative and makes the market system flexible. Economic Inequality-As a result of inequality of access to opportunities, the rich grow richer and the poor grow poorer.


SOCIALISM: Planning-The Planning agency of the Government decides what to produce and how to produce. Consumer Sovereignty-Unlike capitalism, the producers do not produce what consumer desire, because the consumers choice is replaced by the Governments decisions. Motivational System-No self interest, but production is decided by government planners/guided on the basis of usefulness to the society as defined by the government. Organization of decision making and coordinating economic decisions - Is Public Enterprise There is no private ownership, everything under the common organization and owned and run by the government. Income Equality-Fair distribution of income based on the principle: To All According to their needs, From All According to their abilities. ISLAMIC ECONOMIC SYSTEM: Motivational System-Attain falah in this world and hereafter. Organization of decision making and coordinating economic activities By a mixture of healthy competitive market mechanism, democracy and a positive role of the government, all guided by public interest under Maqasid Al-Shariah. Focus of Economic power-Private sector, public enterprise, cooperatives, state. Ownership-multifaceted; private, public, state. Distribution of Income-according to work, need, ownership, zakat and volunteer sector (Qard Hasanah, Sadaqah, Khairat, etc.)

Discuss the main objectives in Capitalism, Socialism and Islamic Economic System Economic system consists of economic institutions which try to solve the basic economic problem in the light of the beliefs, values and policies of a people. The basic economic problem faced by every economy is the problem of scare resources and unlimited human wants. Given this problem, the economic systems try to fulfill the needs of their people by answering the following three primary questions in economics. They are 1) What to produce? 2) How to produce? 3) For whom to produce? Basically in economics there are three types of philosophical economic systems. They are market economy (capitalism), command or planned economy (socialism) and Islamic economic system. These three systems answer the above three questions in accordance with their philosophy and their explanations are as follows: 1) Market Economy: It is also called capitalism and is the most widely practiced economic system today. For example, the United States and most of the European countries practices Capitalism in principle. In Capitalism the resources are owned and controlled by the individuals or privately. The role of the government is to create conditions that facilitate and ensure smooth and efficient functioning of the market. The government performs this role as a neutral umpire. Capitalism answers the above three basic questions as follows: What to produce: As in its name, market, the power to decide what to produce is in the hand of market, since the consumer or buyer is Sovereign. Therefore, producers should produce what the consumers want, as the main objective of the producers is to maximize





their profit. This determination is based on the market mechanism where the demand meets the supply and it will determine the price of goods and quantity that will be purchased and produced; also called equilibrium. How to produce: The main aim of producers is to maximize their profit. This can be done either by increasing the price of the product or reducing the costs or both. However, generally it is difficult for the producers to raise their price due to high competition in the market, leaving the cut-cost option. Therefore, producers try to reduce their cost by enhancing efficiency in their production process. Thus the concept of efficiency tells the producers how to produce. Efficiency can also be improved using technology in their production process. For whom to produce: Again, producers cannot produce what they cannot sell in the market because of the consumers behavior. Therefore, they will produce what the buyers want. This can be derived from the market demand. Therefore, sellers will sell goods and services only to those who are able and willing to pay the market price of the goods produced. FOCUS: Capitalisms main focus is on Economic growth. Command Economy: It is also called Socialism or planned economy. Unlike Capitalism, the resources in the socialist economy are owned and controlled by the government, for example, former USSR, and Peoples Republic of China (China is slowly moving to capitalism in recent years). Their philosophy is to provide goods and services to whole community without discrimination. Therefore, the government will appoint a planning committee called Central Planning Board makes the plans for whole nation. The Socialism answers three questions as follows. a) What to produce: Since government has all power in Socialism, Central Planning Agency will decide what goods to be produced and these goods services will be provided to the people. Buyers have no choice to decide what the producers should produce neither can producers decide. However, the advantage is the system guarantees that the basic needs (i.e. food, clothing, shelter, health and education) of all will be fulfilled whether they are able to pay for it or not. b) How to produce: Since the government owns all the resources and factories and agricultural farms, business. Hence it is the government which decides what to produce, all the decisions about what to produce and how much to produce are made by the National Planning Board of the government. The planning Board is responsibilities for setting up the short run and long run production targets for the entire country and also for the economic development. The method of production is also decided according to the plan by the production managers of factories who are government employees. Since all production is run according to the government plan and no profit motive and incentives are involved it leads to inefficiency in production. Since their main concern is to provide goods and services to the people, not maximizing profit, the basic needs of all will be met at any costs. c) For whom to produce: Everybody in the socialist economy will be provided the basic needs unlike the market economy, thus eliminating unequal distribution of income as the system is based on the principle, TO ALL ACCORDING TO THEIR NEEDS, FROM ALL ACCORDING TO THEIR ABILITIES. These kinds of guarantees also take away the motivation for hard work and breed inefficiency in to the system. FOCUS: Socialisms main focus is on distribution.



Islamic Economic System: unlike the above two economic systems (Capitalism and Socialism), Islamic economic system is based on revelation. Muslims believe that the resources which are provided to us should be used to gain falah i.e. success in this world and in the hereafter. A just, halal and efficient use of resources to pursue self interest guided by the public interest is the only means to achieve happiness in Aakhirah. Therefore, their doctrine on the economic system is very different. Isalmic Economic System answers the above three basic questions as follows:





What to produce: In Islam, it is important to provide goods and services that are needed by the people and consumers will decide what to produce but it must be permissible (halal) in Islam and meet the criteria of public interest as well. Individuals can own the resources once they meet this criteria and also acknowledge that this ownership is only an Amanah (trust) for which they are accountable because actual absolute owner is Allah (SWT). Therefore, producers will produce those goods which are permissible by Shariah and which have demand in the market. Which is decided by market mechanism. How to produce: The producers are allowed to maximize the profit in line with the goal to achieve falah. Thus, producers will produce halal goods and services subject to the criteria of public interest rooted in Maqasid-al-Shariah. Efficiency must be achieved because resources are Amanah and must be utilized wisely, and not wasted or abused. Hence implementing technologies, with concentration on society and care for environment is strongly recommend. For whom to produce: It is a duty of Islamic state to provide the basic needs to people, therefore, necessities would be provided to every single person in the community. For this reason the government is also allowed to own resources. Hence Islamic economic system is more realistic and practical as it maintains private ownership which is the source of motivation for hard work, efficiency, creativity and innovation while at the same time allowing government the access to resources to help the poor and the underprivileged. Thus, there will be production for those willing and able to pay also for those who are too poor to be able to pay. FOCUS: Islamic economic systems main focus is growth with socioeconomic justice while preserving public interest. Therefore, the main difference compared to other two economic systems is that Islamic economic system is both humane and efficient and establishes a moral economic system that integrates economics and moral values for the good of the entire society. Rich can continue to be richer and not only that poor are not left out, they have every chance and support to improve their lot within the market framework. Thus, motivation remains as the fundamental engine of the economy ensuring efficient.


Explain scientific methodology. Science is a systematic study meaning that it has its process, stages and procedures and methods. The basic idea in scientific method is cause-and-effect which tell us that Y will happen if X change and we can come to a conclusion. There are steps in scientific method of study. Firstly, we should make observations relevant to the phenomenon we want to study meaning that collecting data of the relevant variables which are related to the phenomenon we are interested in studying. For example, the quantities demanded of a at certain ranges of prices. After the observation, we should look at the collected data and see whether there is any relationship in the data or simply find a trend. For example, from the collected data about the good a, we may know that when the price of good a increase, its quantity demanded falls. From this trend we can make a model (i.e. relationship between variables) for our study. Next step is to form a hypothesis. A hypothesis is an occurrence of a situation which may the place if a certain relationship between variable exists. At the time of the formulation of the hypothesis this relationship between variable exists. At the time of the formulation of the hypothesis this relationship may not be actually obvious or real but purely our educated guess. That is why we collect the data, and conduct the experiment to test whether our presumed relationship of variables are correct or not. In other words at the tome of the formulation of hypothesis we are not sure if the relationships, as we understand them, are actually real and true or not. For example, some people believe that those who eat a lot of chocolate regularly as a habit would gain weight. This is only a hypothesis. Some people think it is true, others may dismiss it as untrue. So we need to collect more data and test the hypothesis whether there is a positive relationship between regular chocolate intake and weight increase or not. After forming the hypothesis, we need to test the hypothesis from the collected data, according to the statistical method. This testing hypothesis is to check whether the hypothesis or my view is correct or not. If the hypothesis is not correct, we need to collect more data because the data we had collected might be insufficient or the variable taken might be irrelevant or the relationship between the variables may be different from what we understand it to be. Therefore, after collecting new data, we need to follow the same steps as discussed above. If the experiments prove that our hypothesis is correct, we need to collect more data on same variables to repeat the test to confirm and strengthen the hypothesis and if it is proven correct again, it becomes a theory or principle. In real world the usefulness of scientific theories and principles is that it allows us to make predictions and make policies on the basis of those predictions to solve problems. If suppose scientifically it is proven true that regular intake of chocolate leads to weight increase, then parents right from the beginning make sure that they control the chocolate intake of children to keep them healthy. In other words on the basis of this cause and effect relationship and the resulting prediction of weight gain the parents will ADOPT a POLICY of BALANCED DIET to keep the children healthy. This is the significance or power and usefulness of science.

What is the significance of scientific method? The power of science is prediction and the usefulness of science is in making policies on the basis of prediction to solve the problems. Using scientific method, we can derive and prove a


hypothesis and this hypothesis can predict the outcome, like a doctor prescribes medicine for a certain disease because he knows, in certain situations the medicine can cure the patient as it cured other patients in the same conditions in the laboratory experiments. Thus, the use of medicine (policy) is based on the prediction. Therefore, we can predict the changes in quantity demand. For example, if there is a change in price, or what will happen to the economy if the interest rates rise from 5% to 7%, for example. Thus, scientific method is significantly important for an effective judgment and decision making in the contemporary competitive markets.