Don Patinkin criticized the neoclassical assumptions of homogeneity and dichotomization. He proposed the real balance effect to reconcile goods and money markets. The real balance effect posits that changes in the price level affect real purchasing power, which impacts demand for goods. When prices rise, real balances and goods demand fall, pushing prices back down. This feedback loop between prices, real balances, and goods demand is represented using the IS-LM model, where a fall in prices shifts the LM curve right, raising output and employment until full employment is reached. Patinkin argues this real balance effect denies the homogeneity assumption and integrates goods and money markets.

1. R.SENTHAMIZH VEENA
BHARATHIDASAN UNIVERSITY
TAMIL NADU

2. PATINKIN REAL BALANCE
EFFECT
 Don Patinkin – work – “Money, Interest and
Prices”
 Criticises Cambridge economists for
homogenetity and Dichotomisation
 Reconciles through real balance effect

3.  The homogeneity hypothesis states that
the demand and supply of goods are
pretentious only by relative prices. It
means that a doubling of money prices
will have no effect on the demand and
supply of goods.
 Therefore this homogeneity hypothesis
precludes the price level from affecting
the goods market as well as the money
market.

4.  Patinkin criticises this hypothesis for its
failure to have any determinate thesis of
money and prices.
 Another closely related presumption which
Patinkin criticises is the discrimination of the
goods and money in the neo-classical study.
 This dichotomisation means that the relative
price level is determined by the demand and
supply of goods
 Absolute price level – dd & ss of money.

5.  Similar to the homogeneity hypothesis, this
presumption also implies that the price level
has completely no effect on the monetary
segment of the financial system and the level
of monetary prices in turn has no effect on
the real segment of economy.
 After reproaching the neo-classical
presumptions outlined above, Patinkin puts
together the money market and the goods
market
 which is based not only on relative prices but
also on real balances.

6. Real balances mean the real purchasing
power of the stock of cash holdings of
the people.
 When the price level changes, it affects the
purchasing power of people’s cash holdings
which in turn, affects the demand and supply
of goods. This is the real balance effect
 Patinkin denies the existence of the
homogeneity hypothesis and the
dichotomisation presumption through this
effect.

7.  Thus the DD for commodity depends on
both real balance and relative prices as
well
 If price level ↑ - real balance(purchasing
power) ↓ - spend less – DD for goods ↓ -
prices ↓
 price decline – value of money ↑ - DD
for goods ↑

8. Diagrammatic explanation

9.  The real balance effect is represented
diagrammatically by using the IS and LM
technique for the reason that the IS curve
represents the goods market and the LM
curve the money market.
 To start with we take a condition when the
economy is in equilibrium at OY1 level of
earnings when the IS and LM curves
interconnect at point A where the interest
rate is Or1.

10.  Presuming OYF as the full employment level
 Current employment – y1
 Therefore unemployment Y1 – YF
 Certain level of unemp leads to ↓in prices
and wages
 ↑ in real value of money holding
 Shift in LM cure to LM1
 It intersects the IS curve at point B – income
level OY2 - the interest rate drops to Or0
which inspires investment, discourages
savings and enhances consumption.

11.  Even when the interest rate drops to its
minimum level Or0 the level of demand in
the commodity market as represented by the
IS curve is not high enough to lead the
economy to the full employment level OYF.
 Rather, y2 – yf level of unemp exists
 tends to a further drops in wages and prices
and to the hike in demand for consumption
goods which transfers the IS curve to the
right to IS1 so that it overlaps the LM1 curve
at point C at the full employment level OYF.

12.  Thus under conditions of wage and price
flexibility when the IS and LM curves shift
rightwards, the real balance effect
ultimately leads the economy to full
employment level
THANK YOU