4th Lecture PDF

BF1207
PRINCIPLES OF ISLAMIC
ECONOMICS
LECTURE 4
DR ABDUL NASIR BIN HAJI ABDUL RANI

Dean / Senior Lecturer
Faculty of Islamic Economics and Finance
Consumer Theory
• Consumer behaviour is the study of how individual customers, groups, or organisations; select, buy,
use, and dispose ideas, goods, and services to satisfy their needs and wants.
• Therefore, Consumer Theory is the study of how people decide what to spend their money on given
their preferences and their budget constraints. Consumer theory shows how individuals make choices
given their income and the prices of goods and services and helps us to understand how individuals’
tastes and incomes influence the demand curve.
• Consumers can choose different bundles of goods and services. Logically, they will choose the bundle
that gives them the greatest benefit. Example, Munir, who has $200 (his budget constraint / budget
line) and must choose how to allocate it between books and movies (the bundle of goods). If books
cost $10 and movies cost $50, Munir can purchase any combination of books and movies that costs no
more than $200. He could buy 20 books, or 4 movies, or 5 books and 3 movies, or he could keep all
$200 in his pocket. But how can an outsider predict how Munir is most likely to spend his money? This
is the question that consumer theory attempts to answer.
• This question is difficult to answer for several reasons. People are not always rational; sometimes they
are indifferent to the choices available; some decisions are particularly difficult to make because
consumers aren’t familiar with the products or the decision has an emotional component. Consumer
theory therefore makes several assumptions to simplify the process of discerning what consumers will
choose. For example, it assumes that Munir understands his preferences for books and movies and can
decide how much of each he wants to purchase. It also assumes there are enough books and movies
available for Munir to choose whatever quantity of each he wants.
Nature of Consumer Behaviour
1) Influenced by various factors;
a) Marketing factors: such as product design, price, promotion, packaging, positioning and distribution.
b) Personal factors: such as age, gender, education and income level.
c) Psychological factors: such as buying motives, perception of the product, and attitudes towards the product.
d) Situational factors: such as physical surroundings at the time of purchase, social surroundings, and time factor.
e) Social factors: such as social status, reference groups, and family.
f) Cultural factors: such as religion and class.
2) Consumer behavior is not static;
3) Varies from consumer to consumer;
4) Varies from region to region and country to country;
5) Varies from product to product;
6) Information on consumers is important to the marketers;
7) Leads to purchase decision;
8) Improves standard of living; and
9) Reflects status of a customer.
Budget Line
• A budget line shows all combinations of two goods.
• The consumer can buy spending his given money income at their given prices.
• All those combinations which are within the reach of the consumer will lie on the
budget line.
• Consumer Budget states the real income or purchasing power of the consumer
from which he can purchase certain quantitative bundles of two goods at given
price.
Budget Line (Cont.)
• A budget line separates what is
affordable from what is not affordable; Y
• Budget line slopes downwards as more

of one good can be bought by
decreasing some units of the other
good;
Not Affordable
• Bundles which cost exactly equal to 20
consumer’s money income lie on the
Books
budget constraint / budget line; 16
Budget Line /
• Bundles which cost less than 12
consumer’s money income shows under Budget Constraint
spending. They lie inside the budget 8
line; and Affordable
4
• Bundles which cost more than
consumer’s money income are not 0
4 20 24 28 32 36 40 X
available to the consumer. They lie 8 12 16
Movies
outside the budget line.
What is the “Theory of The Firm”
• People need goods and services to satisfy their wants. Firms are the institutions that make
arrangements for their productions. Firms are not only the source of producing what people
need but are also the providers of employment.
• The theory of the firm is the microeconomic concept founded in neoclassical
economics that states that firms (including businesses and corporations) exist and make
decisions to maximize profits.
• Behaviour of a firm in pursuit of profit maximization, analyzed in terms of:
1) What are its inputs;
2) What production techniques are employed;
3) What is the quantity produced; and
4) What prices it charges.
• Maximization of output has two aspects: To produce maximum output from given resources and
to produce a given output using minimum resources.
The Production Function
• A production function is a mathematical expression showing the maximum output (Q) of some
commodity (e.g. computer producion) a firm can produce with given quantities inputs (f) such as
Labour (L), and Capital (K). The general form of the function is: Q = f (L,K)
UNITS OF OUTPUT (Q)

13 38 40 50 53 60 67
11 35 39 47 49 58 65 Focus on the last row of the table, capital
UNITS OF CAPITAL (K)
9 31 38 40 45 55 62 remains fixed at 1 unit but output can be

7 25 35 38 40 48 50 increased from 4 to 20 by employing more and
5 13 25 30 35 39 40 more labour through better utilization of capital
3 8 11 19 25 32 35
capacity.
1 4 7 11 15 18 20
0 1 2 3 4 5 6
UNITS OF LABOUR (L)
Short-Run Production Function
• Let us now see what happens to the firm’s Total Physical Product
(TPP), Marginal Physical Product (MPP), and Marginal Product Revenue
(MPR) when it employs more and more variable inputs (i.e. labour).
• TPP is the total production of output (e.g. computers) by a firm
based on the quantity of inputs used. It emphasizes that production is
measured in quantity units rather than monetary units.
• MPP is the extra output generated by an extra input.
• MPR is the market value (in monetary units) of one additional unit of
output.
Effect of Variable Input on Total Physical Product, Marginal
Physical Product & Marginal Product Revenue
Variable Input TPP MPP MPR

(Labours per Day) (Unit per Day) (Units per Labours) (Marginal Revenue $50)
0 0 0 0
1 0 0 0
2 1 1 50
3 3 2 100
4 7 4 200
5 10 3 150
6 12 2 100
7 13 1 50
8 13 0 0
• Number of daily workers is varied from 0-8:

 0 worker = no production can be made;
 1 worker = cannot produce anything either because some parts of the job require a minimum of 2 people working together;
 2 workers = can get production moving. However, they are able to produce at a rate of only one computer per day;
 3 workers = some degree of specialization becomes possible, and production increases;
 4 workers = things moving very smoothly, and production rises more;
 5-8 workers = boosts the output to the maximum level, but at that point it does no good to add more workers because all
the tools and equipment are in use, and the extra workers would have to stand around waiting for a turn to use them.
Physical Product & Marginal Product Revenue (Cont.)
• The formula for specifying and calculating MPP from TPP is given as: ∆ TPP / ∆ Variable Input
• The MPR is calculated by multiplying together the MPP by the Marginal Revenue.
14
12
Output (Unit per Added
TPP
10
8
Labour)
6
MPP
4
2
0
1 2 3 4 5 6 7 8
Number of Labours
Physical Product & Marginal Product Revenue (Cont.)
Marginal Physical Revenue

200
180
(Units per Added Labour)
160
MPR
140
Market Value
120
100
80
60
40
20
0
1 2 3 4 5 6 7 8
Number of Workers
The Law of Diminishing Returns
Marginal Physical Product
6
Output (Units per Added
5
4
Labour)
3 MPP
2
1
0
Number of Labours
• The part of MPP curve with a negative slope illustrates a principle known as the
Law of Diminishing Returns, (i.e. the principle that as one variable input is
increased while others remain fixed, a point will be reached beyond which the
MPP of the variable input will begin to decrease).
The Law of Diminishing Returns (Cont.)
• The Law of Diminishing Returns applies to all production

processes and to all variable inputs.
• One example, say, farming, with fertilizers as the variable
input; as more fertilizer is added to a field, output increases,
but beyond some points the gain in output brought about by an
additional ton of fertilizer tapers off. In fact, too much
fertilizer could poison the plants, in which case MPP would
become negative.
• In short, any production process could be illustrate the Law of
Diminishing Returns. There can be no exceptions.
BF1207
PRINCIPLES OF ISLAMIC
ECONOMICS
LECTURE 4
DR ABDUL NASIR BIN HAJI ABDUL RANI

Dean / Senior Lecturer
Faculty of Islamic Economics and Finance

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BF1207

DR ABDUL NASIR BIN HAJI ABDUL RANI

• A budget line shows all combinations of two goods.

• Budget line slopes downwards as more

consumer’s money income lie on the

UNITS OF OUTPUT (Q)

9 31 38 40 45 55 62 remains fixed at 1 unit but output can be

Variable Input TPP MPP MPR

• Number of daily workers is varied from 0-8:

Marginal Physical Revenue

• The Law of Diminishing Returns applies to all production

DR ABDUL NASIR BIN HAJI ABDUL RANI

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