A Dynamic Investment Model with Profit-Sharing in an Interest-Free Economy Methodological Issues

Abstract

The present paper is a contribution to the building blocks of an investment
model within the framework of an integrated macroeconomic model of an
Islamic economy. Investment behavior in the model is guided by an Islamicethical
value system and profit-sharing financial contracts. The typical firm’s
investment decision is believed to emerge from a dynamic inter-temporal
maximization exercise within an infinite time horizon. The method of Calculus
of Variations is applied to arrive at the optimal investment and employment
criteria for the firm. The result is then incorporated into a macroeconomic
model to study the behavior of key endogenous variables like national income
and the rate of profit-share. Comparative statics exercised within a general
equilibrium framework reveal the potency of monetary policy but the neutrality
of fiscal policy with respect to output and employment.
Introduction
The past decade has witnessed a tremendous outpouring of interest as
well as effort in the formalization of economic models based on profit-sharing
financial arrangements as an Islamic alternative to the conventional interestbased
economic system. Several macroeconomic models for interest-free
economies have been proposed (Anwar 1987; Habibi 1987; Metwally 1981
& 1983). The rigor of an integrated approach to such macroeconomic modelhg
depends on the rigor of the component models, namely, the consumption,
investment, monetary, and fiscal relationships. Economists have written
extensively on different aspects of consumer behavior in Islamic societies.
Kahf (1978) and Khan (1984), among others, have contributed to the conceptual
and analytical formulation of the consumption function under ...