Efficiency with Rule-Compliance: A Contribution to the Theory of the Firm in Islamic Economics

Abstract. The theory of the firm and the profit maximization have been important areas of debate among Islamic economists as being fore bearers of applicability of conventional economic theory in the Islamic economics. One strand of the debate holds the view that the postulate of profit maximization, as a useful theoretical construct, has to be modified for a firm operating in an Islamic economy, while the other strand highlights that Islamic economy has its own normative rules with an underlying institutional scaffolding derived from the Qur’an and Sunnah. Following the second view, this paper is a modest contribution to the debate by demonstrating that once an institutional scaffolding containing the rules of behavior compliant with the Qur’an and Sunnah is in place, the profit maximization postulate becomes a useful concept in Islamic economic theory. The paper also shows that allocation efficiency with equity is possible provided that the firm is rule-compliant, even in case of a monopoly.Keywords. Allocative efficiency, Firm theory, Profit maximization, Profit sharing, Islamic economics.JEL. P42, D21, C6