Fundamentals of Economics

6. ISLAMIC INVESTMENT

Islamic Investment Theory

 The boundaries of investment in Islam are:

(1) Only permissible activities are allowed.

(2) Investment is based on the desires of human, i.e.
Al-maslahah ummah and also the needs of
dharuriyyat, hajiyyat, and kamaliyyat.

(3) Investment should highlight on well-being besides
profitability.

(4) Its implementation should not go against Shari’ah.
(5) Does not involve any forms of riba’.

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7. NATIONAL INCOME EQUILIBRIUM
IN TWO-SECTOR ECONOMY

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NATIONAL INCOME EQUILIBRIUM
IN TWO-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN TWO-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN TWO-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN TWO-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN TWO-SECTOR ECONOMY (cont.)

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8. NATIONAL INCOME EQUILIBRIUM
IN THREE-SECTOR ECONOMY

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM IN
THREE-SECTOR ECONOMY (cont.)

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9. NATIONAL INCOME EQUILIBRIUM
IN FOUR-SECTOR ECONOMY

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NATIONAL INCOME EQUILIBRIUM IN
FOUR-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN FOUR-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN FOUR-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN FOUR-SECTOR ECONOMY (cont.)

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NATIONAL INCOME EQUILIBRIUM
IN FOUR-SECTOR ECONOMY (cont.)

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10. DEFINITION AND CALCULATIONS
OF THE EXPENDITURE MULTIPLIER

 The expenditure multiplier can be defined as the
ratio of the change in income to the change in
aggregate demand. This aggregate demand can be
referred to investments, government spending, taxes
and balance budget and import.

 The size of the expenditure multiplier which depends
on household marginal decisions to spend, is called
the marginal propensity to consume (MPC) or marginal
propensity to save (MPS).

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

 The multiplier shows that an initial change in aggregate
demand can have a much greater impact on the
equilibrium level of national income. The expenditure
multiplier denoted by K can be measured by:

 Since the size of K depends on MPC and MPS,
therefore K can be measured using the following
formula:

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

 The investment multiplier is the ratio of an increment in
national income to an initial increase in investment. It
shows that any increase in public or private
investment spending has a more than proportionate
positive influence on aggregate income and the overall
economy.

 The investment multiplier can be measured as:

 Alternatively, it can be expressed as: All Rights Reserved

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

 The government spending multiplier is a ratio of an
increment in national income to an initial increase in
government spending. It shows that any increase in
government spending has a more than proportionate
positive influence on aggregate income and the overall
economy.

 Government spending multiplier can be measured as:

 Alternatively, it can be written as: All Rights Reserved

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

 The tax multiplier is a ratio of a decrease in national
income to an initial increase in tax. It shows that any
increase in tax will have a negative influence on
aggregate income and the overall economy.

 The tax multiplier can be measured as:

 Thus, it can be expressed as:

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

 The balanced budget multiplier occurs when there is an
equal change in government spending (G) and taxes (T).

 An equal increase in autonomous government
expenditure and autonomous taxes will lead to an
increase in the equilibrium level of national income, while
an equal decrease in autonomous government
expenditure and autonomous taxes will lead to a decrease
in the equilibrium level of national income.

 The balanced budget multiplier can be measured as:

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

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DEFINITION AND CALCULATIONS OF
THE EXPENDITURE MULTIPLIER (cont.)

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11. INFLATIONARY GAP AND
DEFLATIONARY GAP

Inflationary Gap

 An inflationary gap can be defined as a situation where
national income exceeds the full employment level.

 The increase is only the increase in the nominal income,
but no real increase in goods and services.

 When aggregate demand exceeds full employment
level, inflation will occur. An inflationary gap may be due
to an increase in aggregate expenditure.

 To reduce the inflationary gap, a contractionary policy
can be implemented.

 The government can practise contractionary fiscal policy
by reducing government expenditure and raising taxes.

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

Deflationary Gap

 A deflationary gap occurs when national income is not
at full employment.

 The deflationary gap is a situation where the national
income is below the full employment level. This shows
that resources are not fully utilized.

 To reduce the deflationary gap, expansionary policies
can be implemented. The government can reduce
taxes and increase the government spending.

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

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INFLATIONARY GAP AND
DEFLATIONARY GAP (cont.)

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12

CHAPTER

MONEY, BANKING AND THE FINANCIAL
SYSTEM

LEARNING OUTCOMES

At the end of this chapter, you should be able to:
 Discuss the definition, characteristics and functions of money.
 Differentiate between transaction, precautionary and speculative

motives of demand for money.
 Explain the concept of money supply, and define M1,M2 and M3.
 Discuss money market equilibrium.
 Discuss functions of central banks and the types and tools of

monetary policy.
 Discuss functions of commercial banks and calculation of credit

creation.
 Describe Islamic banking products.

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MONEY

Definition

 Money is defined as anything that acts as a medium of
exchange; any commodity that is generally acceptable
as a payment for goods and services.

Types of Money

 Commodity money: Items such as cowrie shells, cattle,
tea, sheep, tobacco are used as money.

 Metallic money: Metals used as money were iron, tin,
copper, silver and gold.

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MONEY (cont.)

 Paper money: Legal tender approved by the government
to circulate as a mean of payment, such as dollar bills.

 Token money: Money which has a lower metallic value
than its face value, such as 50 cent coin.

 Fiat money: Any item issued by the central bank and
declared by government as money. It consists of paper
money and coins.

 Bank money: Money deposited in a current account or
demand deposits.

 Plastic money: Credit cards or debit cards which are not
money.

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MONEY (cont.)

Characteristics of Money

 Acceptability: must be widely accepted as a medium of
exchange.

 Durability: able to keep for a long period of time and
withstand the wear and tear of many people using it.

 Divisibility: must be easily divided into small units.
 Portability or transportability: easily carried around.
 Scarcity, but not too scarce or noncounterfitability: relatively

scarce and hard for people to obtain.
 Uniformity or homogeneity: in the same weight and design.

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MONEY (cont.)

Functions of Money
(1) A medium of exchange
(2) A store of value
(3) A unit of account
(4) A standard for deferred payment

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MONEY (cont.)

(1) A Medium of Exchange
 Money is widely accepted as a method of payment for

transaction purpose.
 Money is considered as the most liquid form of wealth

as it is accepted by all buyers and sellers.
 Without money, buying and selling can only take place

through system barter which bears the problem of
double coincidence of wants.

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MONEY (cont.)

(2) Store of Value and Wealth
 Money enable people to buy and sell at different times

and at different places because it has the ability to hold
value over time.
 Money acts as the mechanism for future spending or
defer our consumption until the future.
 To act as a store of value, money must be able to be
reliably saved, stored, and retrieved.

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MONEY (cont.)

(3) Measure of Value and a Unit Account
 To measure the value of all goods and services,

quoted in dollars and cents in economic transactions.
 In other words, money serves as a common measure

of value.
 Money allows people to keep accurate financial

records and calculate profit and loss.

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