Patinkin money theory. In his theory he Criticizes classical quantity theory of money and balance approach. He introduce " Real balance effect"

1. Monetary theory
Topic: Patinkin’s monetary theory
Supervisor: dr. Waqqas Qayyum
By: Rashid nasir
Reg: 756-se/mseco/f23
School of economics
International Islamic university Islamabad

2. Table of contents
 Classical Quantity Theory of Money (QTM)
 Cambridge Cash-Balance Approach:
 Money Market
 Good Market
 What Is Real Balance Effect
 Patinkin’s Real Balance Effect Explained
 Real Balance Effect on Aggregate Demand
 Don Patinkin theory Assumptions

3. Don Patinkin, in 1956 Quantity theory of Money
Engaged in a critical examination of both the Classical Quantity Theory of Money
(QTM) and the Cambridge Cash-Balance Approach
Classical Quantity Theory of Money (QTM)
 Classical QTM often assumed a constant velocity of money. Patinkin argued
that this assumption is unrealistic because velocity can change due to various
economic factors.
 Patinkin criticized the classical economists for neglecting the real balances
effect. He argued that changes in the real supply of money (adjusted for
changes in the price level) can influence real economic activity.

4.  The Classical QTM often didn't explicitly consider the role of interest rates in
determining the demand for money. Patinkin highlighted the importance of
interest rates in influencing money demand.
 Classical economists assumed full employment in their models. Patinkin
argued that this assumption was unrealistic and that variations in the level of
employment should be considered in the analysis.
Cambridge Cash-Balance Approach:
 Patinkin criticized the Cambridge economists for not distinguishing clearly
between the transactions demand for money (for facilitating transactions) and
the real balances effect (the desire to hold money for its own sake).
 He argued that the Cambridge approach did not adequately address the
income elasticity of money demand. Changes in income can affect the
demand for money, and this should be incorporated into the analysis.

5.  Patinkin emphasized the importance of liquidity preference in
determining the demand for money. He argued that the Cambridge
approach needed to incorporate the speculative motive for holding
money, as proposed by John Maynard Keynes.
 Cambridge economists were criticized for not providing a dynamic
analysis of how changes in the money supply affect the economy over
time. Patinkin advocated for a more dynamic approach to monetary
theory.

6. Don Patinkin 1956 sought to reconcile the money market and the goods market
through the concept of the real balance effect. This reconciliation is a key aspect of
his analysis of the Quantity Theory of Money (QTM).
Money Market:
In the money market, individuals decide how much of their wealth to hold in
the form of money. This decision is influenced by the nominal interest rate. As
the money supply increases, the nominal interest rate tends to fall.
Goods Market:
In the goods market, individuals decide how much to consume and how much
to save. The real balance effect comes into play here. An increase in the money
supply leads to a higher level of real balances (the purchasing power of money)
for individuals. This increase in real balances affects their consumption
decisions.

7. The real balance effect
Real balance effect is also known as "Patinkin effect" is developed by Jewish
economist Don Patinkin by published a well-known book titled "Money, Interest
and Price" in 1956.
Don Patinkin states that an increase in the amount of money in the economy first
affects the demand and relative price levels and then the absolute prices.

9. Patinkin’s Real Balance Effect Explained
 Real balance.’ In an economy, it refers to the purchasing
power of the public or the money (stock of money) with them
 Hence, Patinkin disproved the quantity theory using the real
balance effect. It states that as the money supply increases, the
demand and price levels for goods and services and the
absolute economical prices increase.
 Patinkin believed that price level influences the real balance,
thus affecting the demand. Therefore, the effect has facilitated
the integration of monetary, real, and labor markets.

10. Real Balance Effect On Aggregate Demand
 Firstly, an increase in real balance contributes to purchasing power. This
leads to an increase in consumer spending; thus, demand for goods and
services will go up. To satisfy increased demands, supply will have to rise
too.
 Hence, employment will increase, and demand for labor will drive up
wages. This, in turn, increases the money stock with people as more and
more people are employed
 Another cycle is set, where public money increases trigger a demand-
induced price hike. Over time, the high prices will reduce the purchasing
power of the people. So demand falls, along with general price levels and,
consequently, employment rates.

11. Comparative Statics and Real Balance
Patinkin presents a comparative-static analysis of the equilibriums
corresponding to two different nominal quantities of fiat money.
we write equations for equilibrium in the markets for the four groups into
which all exchangeable items are aggregated commodities(including
services), labor, bonds, and money.
Y0 = full-employment output of commodities (that is, full-employment
real income).
P = price level.
W = money wage rate.
r = interest rate
M0 = exogenously given initial nominal quantity of money.

12. The following are the equations：
F ( Y0 , M /P, r ) = Y0 Commodity equilibrium
Nd ( W /P ) = Ns ( W /P ) Labor equilibrium
Bd ( Y0 , M /P, r ) = Bs ( Y0 , M /P, r ) Bond equilibrium
PL ( Y0 , M /P, r ) = M0 Money equilibrium

13.  If the four equations are satisfied for quantity of money M0, price
level p0, wage rate w0, and interest rate r0, then, when the
quantity of money is multiplied by k and becomes kM0, the
equations are satisfied at price level, wage rate and interest rate of
kp0, kw0 and r0.
 In the new equilibrium, prices and wages have changed in the
same proportion as the quantity of money and the interest rate is
unchanged.

14. Don Patinkin theory Assumptions:
 It is assumed that an initial equilibrium exists in the economy, that
the system is stable, that there are no destabilizing expectations and
finally there are no other factors except those which are specially
assumed during the analysis.
 It is assumed that there are no distribution effects, that is, the level
and composition of aggregate expenditures are not affected by the
way in which the newly injected money is distributed
 It is also assumed that there is no money illusion. Thus, Patinkin
has discussed the validity of the quantity theory only under
conditions of full employment, as according to him Keynes
questioned its validity even under conditions of full employment.

15.  In Patinkin’s approach we reach the same conclusion as in the
old quantity theory of money but we employ modern analytical
framework of income-expenditure approach or what is called
the Keynesian approach. In other words, Patinkin has
rehabilitated the truth contained in the old quantity theory of
money with modern Keynesian tools.
Thank You Sir!