Factors of Production in Islam and

Factor Markets in Islamic Framework

Summary of the Previous Lecture

In our previous lecture we discussed the following;
we discussed the concept of money in Islam and
the conventional economic system.
Watched the animated documentary about the
evolution of conventional banking system and role
of money as debt. And the implications of having
fiat money like;
1.Credit Creation
2.Inflation
3.Unjust wealth appropriation
4.Deposit multiplication

Learning outcomes
After this lecture you will be able to
Understand the conventional concept of
factors of production, i.e. land, labor,
capital, and entrepreneur.
Understand the concept of factors of
production in Islamic economic system.
Role of money as of being a factor of
production.

Factors of Production in
Islamic Economic Framework
First we see what are the factors of production in
conventional economic system:
Factors of production are the Inputs that provide
a productive service in a production process.
Conventional economic theory suggests four
factors of production, i.e.
1. Land
2. Labor
3. Capital
4. Entrepreneur

Factors of Production in Conventional Economic System

Factors of Production in Conventional Economic System

Name of Owner of Reward of Nature of the

the Factor the Factor the Factor Factor
Land

Landlord

Rent

Natural resources

Labor

Laborer

Wages

Human factor

Capital

Money Lender Interest

Man made factors

Entreprise

Entrepreneur

Man made factor

Profit

Factors of Production in Conventional Economic System

Factors of Production in Conventional

Economic System
Capital is recognized as money and physical capital.
Reward of capital is interest rate which suits the money
capital but it is treated as price of the physical capital
too. Logic suggest that physical asset should earn rent
per machine or per capital asset.

Factors of Production in Islamic

Framework
All productive inputs are grouped into two
categories;
1.Factor inputs: those inputs that dont get
consumed in the production process.
2.Consumed inputs: those inputs that are
consumed during the production process and lose
their original nature and shape, e.g. fuel, raw
cotton, plastic, etc.

Factors of Production in Islamic

Framework
Money as factor of production:
Money is recognized as consumed input and
become useful only when converted into
consumed input or factor input.
Money itself is not considered a factor of
production but it has the potential to become a
factor of production.

Rewards for the Factors of Production

Hired Factors of Production (HFP): all those
factors that earn ujrat (wage or rent), e.g. labor
earns wage, land earns rent, machinery earns
rent etc.
Entrepreneurial Factors of Production (EFP): the
factors that face risk instead of earning a fixed
wage or rent, e.g. entrepreneur, capital assets
employed in the production process.
Factor inputs can become HFP or EFP.

Rewards for the Factors of Production

For factor inputs that opt to become HFP the
reward is ujrat or rent; money not being a factor
input can not earn any ujrat or rent (interest). All
the consumable inputs can neither be rented nor
they can earn any ujrat.
Those factor inputs that opt to become EFP the
reward is profit (or loss) against the risk
associated with new business venture.

Entrepreneurial Factors of Production (EFP)

EFP is the combination of human and non-human resources
that are willing to bear risks involved in initiating or participating
in a productive economic venture.
EFPs are economic resources when confronted with a choice
to work for wage or to have their own work, decide in favor of
their own work. Sometime economic resource have no choice
but to become an EFP, e.g.
1. A person having money cant earn interest (ujrat) on it.
2. Sometime wage rate or rent rates are so low that the person
prefer not to sell the labor or rent out the property.

Entrepreneurial Factors of Production (EFP)

Decision making and risk bearing are two entrepreneurial
functions, where decision making is solely upon human
resources while the risk bearing can be done by the human
resources and physical or monetary resources as well.
Entrepreneurship is to visualize an opportunity and decide to
initiate a productive activity in an innovative way and face all
the associated risk with it.
An entrepreneur may not be a good manager, so this type of
organizational capabilities (managerial, clerical, security etc.)
can be hired against an ujrat.
Organizers earn ujrat while entrepreneurs earn profits (face the
risk of loss)

Hired Factors of Production (HFP)

All the resources that offer productive services for a
definite reward known in advance are called HFPs.
All factor inputs can become HFP but none of the
consumed inputs can become HFP ("Organization" and
"managers" as factors of production too are treated as
HFPs as long as they are not willing to bear the
entrepreneurial risks).

HFPs are employed by EFPs, i.e. employment

opportunities will increase with the increase in
entrepreneurial activities. Demand and supply of HFPs
will determine the ujrat and rent.

Hired Factors of Production (HFP)

HFPs include land, labor, physical capital good and
human capital (monetary resources are excluded).
HFPs are derived from the same resources which
can offer themselves as entrepreneurial resources.
The supply and demand for HFPs thus competes
with the supply and demand of EFPs.
All these resources have to make a choice whether
to opt in favor of becoming an HFP and get an Ujrat
or to become an EFP to enjoy the profits.

Institutional Framework in
Islamic Economic System
Some of the institutional frameworks that explain
the nature of factors of production and factor
market are as follows:
1.Commodity Market
2.Factor Market for HFP
3.Institution of Participation
4.Institution of Social Insurance

1. Commodity Market
Islam rates trading activities very high and the
institution of commodity market is one of the
most important institutions in Islam.

Islamic laws regulate the commodity market

operations and ensure the free market system
with restrictions on the bad practices (monopoly)
and misallocation of the resources.

2. Factor market for HFP

Only those goods/resources can be rented or hired
which are not "consumed while they are used.
Renting or hire is the sale or purchase of the
benefits/services of physical assets or resources
including human resources.
The assets or resources that generate benefits in the
form of real goods (like tree giving fruits or animals
giving milk) can not be rented for such benefits.
Financial resources can not be rented because they can
not generate any service without being "consumed".

2. Factor market for HFP

Renting of land for agricultural purposes:
There is some difference of opinion about renting land for
agricultural purposes. A minority of Islamic scholars
disallow renting of land for agricultural purpose. The
majority of Islamic scholars allow renting of land for
agricultural purpose within the general principle of renting,
which is, that any physical resource that is capable of
generating a productive service is capable of being rented
or hired.
Land is supposed to be just like a machinery which
provides the service of being productive when the inputs
are used.

2. Factor market for HFP

Rented goods should generate permitted
economic benefits which are known and certain
otherwise the goods cant be rented out.
Those goods which are prohibited to rent or
generate prohibited services cant be rented.
Any loss or damage to the property not willfully
caused by the tenant is to be borne by the
owner.

2. Factor market for HFP

Ujrat is to be determined by the supply and demand
forces.
Ujrat, by definition, is fixed and known-in-advance. Ujrat
should be definite and known in advance.
If Ujrat is uncertain it will be treated as profit and the
resources rented on such an Ujrat will be called
entrepreneurial resources.
Ujrat cant be in terms of same or similar
benefits/services, e.g. ujrat of a machine cant be in
terms of allowing the use of a similar machine. It is,
however, allowed to pay Ujrat of a machine by allowing
the use of a building, or by allowing the use of a different
kind of machinery.

2. Factor market for HFP

The resources that have been allowed to be rented or hired
include:

1.Land for (cultivation, or construction, or plantation etc.)

2.Animals (for transportation or for help in cultivation)
3.Human Resources: This includes manual labor such as
loader, unskilled worker, servants etc., as well as such
skills and professions as doctors, lawyers, professors,
organizers, managers etc.
4.Buildings (such as houses, shops, factories, stores etc.)
5.All such other goods that are capable of rendering
services without being consumed in a production process
(machinery, tools, dresses, tents, jewelry, etc.)

2. Factor market for HFP

Factor markets for HFPs are almost similar to
conventional factor market for land, labor, and capital,
however, there are some differences:
1.Monetary resources cant become HFP which is not so
in conventional framework.
2.The supply of HFP factors particularly of labor results
in the process of a choice whether to be a hired factor or
an entrepreneurial factor whereas in the conventional
theory, their supply results in the process of a choice
whether to get employed or not to get employed.

3. Institution of Participation
In Islam entrepreneurial resources are encouraged to
participate and bear the risk to earn profits (loss).
Participation will be on profit and loss sharing basis,
e.g. Musharakah and Mudarabah.

There is a profit and loss sharing mechanism in a

participation, i.e. profits can be shared at any agreed
rate whereas losses should be shared according the
proportion of investment. The relative productive worth
of the resources invested will determine the profit ratio.

3. Institution of Participation
In a capitalist system
All productive resources are rentable. In an economy with
high business risks, all productive resources will prefer to
be on Ujrat rather than to be entrepreneurial resource.
Scarce factors obviously will have high Ujrat so there will
be no compelling reason to opt for participation in an
economy with high entrepreneurial risks are very high.
In labor abundant developing countries wage rates are so
low that people prefer to sit idle. The surplus labor fails to
get participation from the physical and financial capital
because of high risk.

3. Institution of Participation
Islamic economic system encourage participation
in many ways:
1.Monetary resources are prohibited to earn rent
but they can participate in entrepreneurial
activities.
2.Obligatory taxes like Zakat is applied on idle
monetary resources. This will encourage the
resources to be invested or participate with
someone else.

3. Institution of Participation
In capitalistic system monetary resources
are available on interest (rent) but are
subject to the credibility of the entrepreneur.
Only the bigger businesses and wealthy
individuals have easy access to monetary
resources. Thus the system make the richer
the richest and the bigger corporations even
bigger.

3. Institution of Participation
In Islam the institution of participation creates demand for
entrepreneurial resources by:
a)creating new entrepreneurs to come into the market to avail
entrepreneurial opportunities;
b)promoting participation of scarce resources with abundant
resources hence causing abundant entrepreneurial resources to
come into the market as EFP;
c)promoting participation of big entrepreneurs with small
entrepreneurs and hence creating demand for small
entrepreneurs;
d)reducing risk in the economy by distributing risk fairly among
the entrepreneurs and hence making the potential entrepreneurs
to come forward to take up entrepreneurial activities.

4. Institution of Social Insurance

Islam ensures the well being and livelihood of the
people. The institution of social insurance consists
of the following factors:
a.And in their wealth the beggar and the outcast
had due share. (51:19)
b.The institution of Zakat, Sadaqat and charity.
c.The system ensure minimum living needs for
everyone so the entrepreneurial factors would be
encourage to take risks the demand for EFP would
increase which means welfare of the people.

Summary of the Lecture

In this lecture we discussed the following
concepts.
Factors of production in conventional
economic system
Factors of production in Islamic economic
system.