Equilibrium in Factors of Production. Learning Outcomes After this lecture you will be able to; Understand the concept of equilibrium in factors of production

Equilibrium in Factors of Production

Learning Outcomes

After this lecture you will be able to;

Understand the concept of equilibrium in factors of production and how the balance between HFP and EFP is achieved in the economy.

Summary of Previous Lecture

We covered the following topics in the previous lecture;

•Factors of production under conventional economic

system.

•Factors of production under Islamic economic system.

Division of factors of production in consumed and factor

input and their role as HFP and EFP

Factors of Production inIslamic 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

Name of the Factor

Owner of the Factor

Reward of the Factor

Nature of the Factor

Land Landlord Rent Natural resources

Labor Laborer Wages Human factor

Capital Money Lender Interest Man made factors

Entreprise Entrepreneur Profit Man made factor

Factors of Production in Islamic Framework

All productive inputs are grouped into two categories;

1.Factor inputs: those inputs that don’t 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.

Capital

• Man-made resources used for further production

• Examples: machines, raw materials, tools

• Features:Man madeIt increases the productivity of other factors

Land or Capital?

• Ice at Mount Everest

• Ice in a skiing field

• Sea water

• Sea water in a seafood restaurant

• Sharks in the Ocean

• Sharks at the Ocean Park

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.

• EFP’s 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 can’t 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 HFP’s.

• All factor inputs can become HFP but none of the consumed inputs can become HFP ("Organizations" and "managers" as factors of production too are treated as HFPs as long as they are not willing to bear the entrepreneurial risks).

• HFP’s are employed by EFP’s, i.e. employment opportunities will increase with the increase in entrepreneurial activities. Demand and supply of HFP’s will determine the ujrat and rent.

Hired Factors of Production (HFP)

• HFP’s 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

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".

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.



• Rented goods should generate permitted economic benefits which are known and certain otherwise the goods can’t be rented out.

• Those goods which are prohibited to rent or generate prohibited services can’t be rented.

• Any loss or damage to the property not willfully caused by the tenant is to be borne by the owner.

• 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 can’t be in terms of same or similar benefits/services, e.g. ujrat of a machine can’t 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.


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.)


Equilibrium in the Factor Markets

Equilibrium is phenomenon of the forces of supply and demand in the market. We will study the topic under the following headings:

1.Supply and Demand of Hired Factors of Production

2.Supply and Demand of Entrepreneurial Factors of Production

3.Factor Market Equilibrium

Equilibrium in the Factor Markets1. Supply and Demand of Hired Factors of Production

• Marginal productivity will determine the demand for the human resources and physical capital.

• Supply of labor will be determined by the marginal utility of leisure to the laborer.

• Supply of capital goods will be determined by the opportunity cost of producing capital goods.

• The rental of capital goods will really be rental not the interest.

Under the conventional economic system supply of capital is derived from the supply of savings which is determined by the marginal utility of future consumption vis-a-vis present consumption.

Equilibrium in the Factor Markets2. Supply and Demand of EFP


The supply of EFP resources which could also be hired will be determined as a residual out of the total stock of resources left over after getting employed on Ujrat.

Suppose

SR = Total resources capable of becoming EFP or HFP

Su = Resource employed on ujrat

SR – Su = Entrepreneurial supply of resources

SS = Supply curve of hired resources

So = Resources available at constant opportunity cost

DD = Demand curve for the resources


Two things need further elaboration before we go to the demand for entrepreneurial resources.

a)How the SR is determined

b)How the remainder SR - Su become EFP.

Human Resources SR

• Labor

• Entrepreneurs

Labour Supply

• Measured in terms of time (man hour)

• Labour supply = no. of workers x no. of working hours per worker

• Factors affecting labour supply:– Size of population– Size of working population– No. of working hours

How to increase labour supply?

population growth (by natural growth or immigration)

monetary rewards import of labor from other countries retirement age (e.g. from 60 to 70) school leaving age (e.g. from 16 to 17)


SR for human resources: Size of the population and the growth rate of the population. Human resources if can’t get ujrat to their desired level may sit idle or become EFP.

S for capital goods in the country will be the total output of capital goods in the country minus exports plus imports. The Stock of capital goods more than the demand in the economy will become EFP otherwise will be depleted by the annual payment of Zakat.


Factors determining the demand for entrepreneurial resources may be listed as:

a)Capability to visualize a productive activity that would yield him an expected profit greater than the prevailing level of Ujrat for his resources;

b)Risks involved in initiating the project;

c)Supply of other productive resources;

d)Institutional arrangement conducive for free entry in the market.


The supply of different EFPs raises each other's demand. Thus availability of entrepreneurial capital i.e., risk bearing capital will raise the demand for the entrepreneurial human resources and vice versa.

Equilibrium in the Factor Markets3. Factor Market Equilibrium

Summary of the Lecture

In this lecture we covered following topics;

1.Supply and demand for HFP.

2.Supply and demand for EFP.

3.Equilibrium between the supply and demand of

HFPs and EFPs.

Documents

Equilibrium in Factors of Production. Learning Outcomes After this lecture you will be able to; Understand the concept of equilibrium in factors of production