Question

In 6 sentences or less, explain Patinkin’s Critique of the classic dichotomy and his proposed modification of the Walrasian system analysis. Note: do not copy statements from the papers referenced. You are expected to understand the Critique and summarize it in your own words in a way that others would understand.

Answer 1

Patinkin’s main point of contention was that the advocates of the cash balance approach had failed to understand the true nature of the quantity theory.Their failure was revealed in the dichotomy which they maintained between the goods market and the money market. Far from integrating the two, as had been claimed, Patinkin held that the neo-classical economists had kept the two rigidly apart.An increase in the stock of money was assumed to generate an increase in the absolute price level but to exercise no real influence upon the market for commodities. One purpose of Patinkin’s analysis was that only by exerting an influence upon the market for commodities, via the real balance effect, could the strict quantity theory be maintained.Part of Patinkin’s attack revolved round the nature of the demand curve for money, which according to Patinkin, Cambridge School had generally assumed to be a rectangular hyperbola with constant unit elasticity of the demand for money. As a matter of fact, such a demand curve was implicit in the argument that a doubling of the money stock would induce a doubling of the price level.Patinkin used the ‘real balance effect’ to demonstrate that the demand curve for money could not be of the shape of a rectangular hyperbola (i.e., the elasticity of demand for money cannot be assumed to be unity except in a stationary state), and moreover, such a demand curve would contradict the strict quantity theory assertion which the Cambridge quantity theorists were trying to establish Patinkin’s main point is that cash balance approach ignored the real balance effect and assumed the absence of money illusion under the assumption of ‘homogeneity postulate’ and, therefore, failed to bring about a correct relation between the theory of money and the theory of value.

The classical dichotomy was explicit or implicit in the writings of principal neoclassical writers as Cassel, Fisher, Divisia, Marshall, Pigou and Walras according to Patinkin. This dichotomy is invalid since these writers assume that the real part of a general equilibrium system determines the relative prices of commodities and then an equation of the form MV = PQ determines the absolute price level. It can be seen that in such a case the excess demand for money is identically equal to zero and the level of money prices is therefore indeterminate.

First we must note that the introduction of money into the utility function is at a first glance, completely arbitrary and without any justification. It can be seen that in such an economy as the one described by Walras, there is no need for individuals to hold money, since there is no uncertainty in his model. The only justification for putting money into the utility function would be the lack of synchronization between receipts and payments when transactions take place. But Walras assumes fixed dates for receipts and payments so that the introduction of money into the utility function seems completely arbitary. The only justification given by Walras for including money balances into the utility function is that he regards money as a circulating capital good which yields services of availability.

Walras never assumed that a change in pu·, does not react back on the real part of the system. Hence there is no reason why we should assume as Patinkin does, that such a change does not react back on the system. The term pu·, appears in the budget constraint of the individuals and this will affect the real part of the system in any case. In other words Walras' system is not decomposable. Hence Patinkin's critique can not be correct and the level of money prices is not indeterminate as he insists. One of the main defects in Patinkin's critique, is that he takes into account only the exchange part of Walras' system leaving outside the theories of production and capital formation, something that has been recently noticed by Morishima (1977).

Although Walras' system is very complex and mathematically incorrect, it retains the properties of a determinate system if it is modifed in some way. In modifying Walras' system, we will retain all of its basic elements, taking into account both the theory of production and capital formation as they appear in the "Elements". However we will differ from Walras in two points. First we will not treat money as a capital good needed for production. Second, the demand for the imaginary commodity (E) will be stated explicity as demand for all (and every) capital good. These changes, although they do not alter Walras' system in any serious way, they however simplify our exposition. Furthermore some weaker assumptions will be made, such as the ordinal character of the utility function.

In our opinion it should be clear that Walras' system does not retain the classical invalid dichotomy, although it is far from being self - determined. The above analysis should now explain Patinkin's perplexity for the reversion of Walras' procedure. ·Patinkin writes on this matter: In all his work before the fourth edition of his "Elements", Walras merely posited his cash balance equation on the basis of considerations which were extraneous to the main body of his arguments. More specifically in contrast with his analysis of every other good, Walras did not derive the demand function for money from utility maximization. Indeed he made no use of marginal utility analysis in his monetary theory except to deal with the case of a money which was also a commodity.