Chapter 6 complete

Patinkin’s Integraton of the Monetary Theory and the Value Theory
rofessor Patinkin’s integration of value theory with monetary theory and with the theory of 
employment is a highly impressive architectonic accomplishment, based on a single 
he idea is that of interpreting the demand for real balanc
the utility or safety yielding quality of the balances. This analytical device is 
analogous to the deviation of the demand for the consumer goods from their utility.
The author first incorporates the demand for real balances (money balances deflated 
for the price level) into the theory of consumer choice on the level of micro analysis. Thus, 
for what Patinkin calls the “real balance effect’
The classical quantity theory of money maintains a dichotomy between the monetary 
. It (classicist) assumes that money is a neutral (the classical 
economists’ belief that changes in the money supply affect the general price level, but not 
relative price. Relative price refers to any price expressed as a ratio of another price) and 
having no influence on output, which is governed by real variables like labour, capital, and 
technology. An increase in money supply increases absolute price level without affecting 
relative prices, which are determined in the real sector. Patinkin has rejected the classical 
dichotomy between the monetary sector and the real sector in his monumental work, “Money, 
Interes, and Prices (1965)”. He argued that dichotomy between monetary sector and real 
tent with the quantity theory of money.
William.Fellener, Patinkin’s integration of monetary and value theory”, The American Economic Review, 
Theory
rofessor Patinkin’s integration of value theory with monetary theory and with the theory of 
employment is a highly impressive architectonic accomplishment, based on a single 
for real balances held as 
quality of the balances. This analytical device is 
analogous to the deviation of the demand for the consumer goods from their utility. 
y balances deflated 
for the price level) into the theory of consumer choice on the level of micro analysis. Thus, 
for what Patinkin calls the “real balance effect’
14
etween the monetary 
. It (classicist) assumes that money is a neutral (the classical 
economists’ belief that changes in the money supply affect the general price level, but not 
pressed as a ratio of another price) and 
having no influence on output, which is governed by real variables like labour, capital, and 
increases absolute price level without affecting 
ined in the real sector. Patinkin has rejected the classical 
dichotomy between the monetary sector and the real sector in his monumental work, “Money, 
Interes, and Prices (1965)”. He argued that dichotomy between monetary sector and real 
William.Fellener, Patinkin’s integration of monetary and value theory”, The American Economic Review, 

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Don Patinkin (1954) challenged the classical dichotomy as being inconsistent, with 
the introduction of the ‘real balance effect’ of changes in the nominal money supply.
According to Patinkin, an increase in the quantity of money first influences the 
demand for the commodities and their relative prices through real balance effect and then the 
absolute prices. Thus, Patinkin has attempted to integrate the monetary sector with the real 
sector through the real balance effect. He postulated that the existence of a real balance effect 
in real sectors integrates monetary and real sector.
The early classical writers postulated that money is inherently equivalent in value to 
that quantity of real goods, which it can purchase. Therefore, in Walrasian terms, a monetary 
expansion would increase prices by an equivalent amount, with no real effects on 
employment on output and employment. Patinkin postulated that this inflation could not 
come about without a corresponding disturbance in the goods market. As the supply of 
money increases, the real stock of money balances exceeds and thus, the expenditure on good 
rises, which establish the optimum balance. The rise in price level in the goods market will 
continue until excess demand is satisfied, at the new equilibrium. He thus argued that the 
classical dichotomy was inconsistent in that it did not allow for this adjustment in the goods 
market
15
.
Don Patinkin’ real balance effect theory is based on the following assumptions: 
1.
Money could not change the real magnitudes of economic variables. That is they 
believe in neutrality of money; 
2.
Expectations are unit elastic; 
3.
All prices are flexible; 
4.
No distribution effect exists; and 
5.
There is no money illusion.
Patinkin believe that when price level changes, it affects the purchasing power of 
the people; the real purchasing power of the people is real money balance, which people hold 
in the form of cash balances, which ultimately affect the demand for goods and services. This 
is the real balance effect. 
If the price level increases, real money balances decreases (i.e., purchasing power 
of money reduces). The reduction in real money balances will have two effects: (i) demand 
for commodity will be reduced,(ii) wages and prices will fall (because demand for 
commodities reduces). The initial decline in demand for commodities will generates 
involuntary unemployment but this type of unemployment will not last for long time because 
decline in demand for commodities will reduce wages and prices and reduction in prices and 
wages will increase real money balances. This real money balance effect tends to increase 
demand directly or indirectly through the interest rate. With sufficiently large fall in prices 
and wages, full employment level of income and output will be restored.
15.
Don Patinkin, 1987, “Neutrality of Money”, The New Palgrave: A Dictionary of Economics, v.3,p639-
644. 

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Patinkin’s general equilibrium model considers three markets:
1.
Commodity market;
2.
Labour market; and
3.
Money market. 
The commodity market and labour market comprises together
real sector market. The real balance effect of Don Patinkin is illustrated in the Figure
which rate of interest (i) is shown on vertical axis and income or output (Y) on horizontal 
axis. In Figure 6.5 at income level, Y, IS and LM repres
and income in the goods market and money market respectively. Initially, economy is in 
equilibrium level of output at point E, where both IS and LM curve intersects each other at Y 
= 22.50 level of output. Assuming that full employment level of output is at Y
pressure of unemployment (i.e., difference between Y and Y
fall in prices. This results into an increase in real balances
right to LM1 (see figure 6.5). The LM1 curve intersects IS curve at low rate of interest (i) at 
point E1 at Y1 level of output. Falling interest rate will stimulate inv
income will increase but note that there is still unemployment (i.e., the difference between Y1 
and Y
F
) in the economy at Y1 level of output. This leads to a further fall in wages and prices 
and consequent an increase in demand for cons
investment and this leads to shift in the IS curve to IS1
resulting into full employment level of output (Y
LM curve ultimately leads to 
interest rate falls to minimum level. This shows that money is neutral and the interest rate is 
independent of the quantity of money through the real balance effect.
Patinkin’s general equilibrium model considers three markets: 
Commodity market; 
Labour market; and 
The commodity market and labour market comprises together
real sector market. The real balance effect of Don Patinkin is illustrated in the Figure
which rate of interest (i) is shown on vertical axis and income or output (Y) on horizontal 
In Figure 6.5 at income level, Y, IS and LM represents equilibrium between interest rate 
and income in the goods market and money market respectively. Initially, economy is in 
at point E, where both IS and LM curve intersects each other at Y 
= 22.50 level of output. Assuming that full employment level of output is at Y
pressure of unemployment (i.e., difference between Y and Y
F
) would depress wage rates and 
rices. This results into an increase in real balances, which shifts the LM curve to the 
right to LM1 (see figure 6.5). The LM1 curve intersects IS curve at low rate of interest (i) at 
point E1 at Y1 level of output. Falling interest rate will stimulate investment as a result 
income will increase but note that there is still unemployment (i.e., the difference between Y1 
) in the economy at Y1 level of output. This leads to a further fall in wages and prices 
and consequent an increase in demand for consumer goods. Increase demand boost up 
investment and this leads to shift in the IS curve to IS1, which intersects LM2 at point E2 
resulting into full employment level of output (Y
F
). Thus, the rightward shift of the IS and 
LM curve ultimately leads to economy to full employment level, even in a situation when the 
interest rate falls to minimum level. This shows that money is neutral and the interest rate is 
independent of the quantity of money through the real balance effect. 
The commodity market and labour market comprises together, which is called 
real sector market. The real balance effect of Don Patinkin is illustrated in the Figure 6.5, in 
which rate of interest (i) is shown on vertical axis and income or output (Y) on horizontal 
ents equilibrium between interest rate
and income in the goods market and money market respectively. Initially, economy is in 
at point E, where both IS and LM curve intersects each other at Y 
= 22.50 level of output. Assuming that full employment level of output is at Y
F 
= 55. The 
) would depress wage rates and 
, which shifts the LM curve to the 
right to LM1 (see figure 6.5). The LM1 curve intersects IS curve at low rate of interest (i) at 
estment as a result 
income will increase but note that there is still unemployment (i.e., the difference between Y1 
) in the economy at Y1 level of output. This leads to a further fall in wages and prices 
. Increase demand boost up 
, which intersects LM2 at point E2 
). Thus, the rightward shift of the IS and 
economy to full employment level, even in a situation when the 
interest rate falls to minimum level. This shows that money is neutral and the interest rate is 

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In summary, we can say that the Don Patinkin,s real balance effect theory: (i) 
eliminates dichotomy between monetary sector and real sector; (ii) it validates the conclusion 
of the quantity theory in equilibrium money is neutral and interest rate is independent of the 
quantity of the money through the real balance effect; (iii) wage-price flexibility leads to full 
employment in the long-run and that the Keynesian underemployment equilibrium is a 
disequilibrium situation.