1. Coordination Mechanisms
How is the allocation of resources to the various production activities determined?
Centralized decisionmaking
- central authority, dictator, communism, socialism
- Decentralized decisionmaking
- laissez-faire, market-economy,
capitalism

2. Market Economies The idea: (Adam Smith, 1776, The Wealth of Nations)
Each individual makes choices based on his/her own self-interests, within the guidelines of the laws.
All exchanges are voluntary and so no exchanges take place that either trader believes is not in his/her self interest.
There are no impediments to trade.
Then, subject to certain important conditions, the resulting economic outcome will be production-efficient and allocative-efficient. An “invisible hand” directs the economy to an “optimal” outcome.

3. Markets
The exchanges that take place in a laissez-faire economy occur in markets.
Markets are the mechanisms through which voluntary exchanges take place. They can have specific physical location (e.g., a supermarket) or not (e.g., “e-bay” or the jobs section of a newspaper’s classified ads).
That is, a market is any mechanism through which “buyers” and “sellers” make exchanges.

4. Markets (cont’d)
Virtually all current economies are “monetary economies” which means that most markets operate as follows:
A particular commodity (good or services) is sold by a seller to a buyer in exchange for a certain amount of money, which is the market price of the commodity.
The market outcome is described by the quantity (the amount of the commodity bought and sold) and the price (units of currency per unit of the commodity).
An alternative market structure: barter

5. How are market outcomes determined?
The Supply and Demand Model

6. Traders and Markets in the Macroeconomy
Traders (Decisionmakers;Sectors)
- Household Sector (Consumers)
- Business Sector (Producers)
- Government Sector
- Foreign Sector (Rest of the
World)
H + B = Two-Sector Economy
H+B+G = Three-Sector Economy
H+B+G+F= Four-Sector Economy

7. Household Sector -Owns the economy’s resources
-Sells the services of these resources to firms in exchange for $’s = factor income
-Purchases goods and services produced by (domestic and foreign) firms in exchange for $’s = consumption + investment (saving)
Pays taxes to the government

8. Business Sector
Employ factors of production, which are purchased from households, to produce goods and services, which are sold to households.

9. Government Sector
Purchases goods and services from the business sector to produce public goods to the the economy (e.g., national defense, police services, public roads, public parks, services of government employees)
Collects taxes to finance these purchases (and borrows from households).

10. The Circular Flow Representation of the Economy
Graphical representation of the activities of the various sectors and the markets that coordinate these activities