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The author would like to thank Ghassem Salehkhou, Mohsin S. Khan and Jagdeep S. Bhandari for their helpful comments.
That is the rate of return is contingent upon the outcome of the projects for which financial resources are made available. This characteristictic makes an Islamic economic model an ideal setting for application of Arrow-Debru-Diamond type analysis of a stock market economy under uncertainty.
Metzler’s model has been extended in a variety of directions. A recent example is the closed economy model presented by Shane (1984). For examples of Metzlerian-type open economy models see Frenkel and Rodriguez (1975) and Claassen (1983). The closed economy model presented here is based on Uzawa (1969), and the open economy model is based on Frenkel and Rodriguez (1975). Insights into the workings of an Islamic economy can be obtained by utilizing these models as demonstrated in this paper.
That an equity-based system has desirable features that improve the shock-absorption adjustment capacity of the economy has been shown by other studies; see, for example, Shane (1984) and Cole (1988).
An index of real capital can be constructed by measuring the earning capacity of the firm (profits to be earned) as the short-run production function shifts. See Uzawa (1969).
It is assumed here that the average propensity to save is a positive function of the market rate of return.
By traditional sources we mean the Quran and the Traditions of the Prophet.
Frank Knight (1971, pp. 130-140) has shown that the neoclassical notion of time preference can also produce either negative or zero rate of discount. See also Olson and Bailey (1981) and Epstein and Hynes (1983).
See for example Montiel (1986) in which the rate of time preference is equal to the marginal product of capital.
See Patinkin (1965) chapters IX-XI for further explanation on the functional forms of the demand equations.
Since Q = F(K), dQ = F′dK and y = F(K) - F′Ef then dy = F′dk -FʺEfdK + F′dEf.
To sign the expressions (45) and (46) it is assumed that FʺEf is to be zero.
Here we have not suggested how the stock of money is increased. The adjustment process depends on whether the change in money supply has “inside” or “outside” sources and whether it is in form of “once-for-all” change or in form of continuous open-market operation in which the government buys and sells equities in order to change the money supply. Moreover, the adjustment process depends also on the way in which the government disposes of earnings from its equity holdings and how the households view the government holdings of equity shares. Nonetheless results obtained in equations (47) and (48) are general and should hold under various assumptions. For further discussion see Metzler (1951, 1952), Mundell (1960), Waud (1970), and Frenkel and Rodriguez (1975).
For the a21 element of matrix A recall that dy = F′dk - FʺEfdK -F′dEf, and dividing by dK yields (F′ - FʺEf - F′ dEf/dK).
The adjustment process is reversed if the domestic rate of return on equities is lower than the foreign rate of return on similar assets.
Recall that the system is homogenous of degree zero in the nominal money stock M and in the exchange rate e, and also that the aggregate asset holders’ demand for real cash balances, L, is assumed proportional to the value of their equity holdings.