Lesson10- TheCircularFlow ofEconomicActivity

IN ODUCTION
Economi cs
The circular fl ow of economic acti vity is a sim-
plified macroeconomi c model ofthe ba sic eco-
nomicrelationshipsin a market economy.This
model gives the st udents an overview ofhow
households, businesses and governmentinter-
act in differentma rketsby exchanging goods
andservices, pr oductive resources (alsoknown
as inputs or the factors of producti on) and
money.
Reasoning
People r espond toincentives .Households have
incentives to pr ovide resources to businesses to
receive income in r etur n.They thenhave
in cent ives to use t heir income to purchas e
goods and services tosat isfy their wants.
Businesses have incent ives toearn pr ofits and,
therefor e, to produce t he goods and services
thatconsumer s want. To produce goods and
services, businesses need to purchase
re sources from households.The cir cul ar -flow
model andthe simulat ion in this lesson
demonstratethese impor t antr elationships .
CONCEPTS
Circular flow ofgoods, services, productive
resources and moneypayments
Inter dependence
Product ive r esources
(nat ural, humanandcapital)
Resource payments
(wages andsalaries, r ent, interest, profit)
CONTENT STANDARDS
7. Mar kets existwhenbuyersandseller s
interact .This interactiondetermines mar-
ketpri ces andthereby allocates scarce
goods andserv ices .
16. Ther e is aneconomicrol e for government
to playin a market economy whenever the
benefitsofa government policy outweigh
itscosts.Gover nments often providefor
nati onal defense,address environmenta l
concerns ,define andprotectproperty
r igh ts,and attempt to make markets more
competiti ve.Most governmentpolicies al so
redi st ribute income.
18. Anation's overalllevels ofincome, employ-
mentand prices are det erminedby the
interact ion ofspendingandproduction
deci sions madeby all households, firms ,
governmentagencies andothers in the
economy.
OBJECTIVES
St udent s will
1. Identifyanddescribe the three t ypes of
productive resources (inputs) andthe kind
ofincome each resource earns.
2. Analyze the economic relationships
betweenhouseholds andbusinessesin a
marketeconomy.
3. Use a circul ar-flow diagram to illustrate
theeconomic relationships amonghouse-
holds,businesses andgovernment.
ECON<1:I ll CS INACTION,'QNATIONALCOL:-:CIL ~ ~ O ~ O EDUCATION,NEWYORK,NY
Sf
. LESSON 10- THE CIRCULAR FLOWOF ECONOMICACTIVITY
LESSON DESCRIPTION
In this lesson,the st udents read aboutmarket
int er acti ons andpart icipate in a si mulation.
"Econoland"involves transactio ns between
bu sinesses andhouseholds in tv 0 kindsof
product ma rkets and resource (or
in put) market s. Theydiscuss how the govern-
mentfit s into this model and transla te their
concl usions int oa circular -flow diagr am.
TIME REQUIRED
7fj minut es: 45 mi nu tes to conduct a nd discuss
the si mula t ion and 30 minutes t ocomplete
. ct ivit ies 10.5 and 10.6
MATERIALS
Note:Prepare material s for t he simulati on
before cla ss, mainly cutting ap artact ivity
sh eets andcr eatingsets ofmater ials for t he
st udents. Ifpossible,lami nate badges,car ds
and money touse in mul tip le classes .
I. Visuals 10.1and 10.2
2. Acopy ofAct ivity 10.1 (t wopages) for each
student
3. Enough copies ofAct ivity 10.2 (one
Business Badge and 10 $100 bill s) for half
t he st udents in t he class.These students
will representbu sinesses.
4.
Enough copiesof Act ivity 10. 3 (five
Human Resources car ds, five Nat ur al
Resources' cards and five Capit al Goods
ca rds) for the r estoft he st udentsin the
clas s,wh owill r epresent households. Mi x
t he set s up so t he cards are not distr ib-
ut ed equally:Make one setwith 15
NaturalResources car ds, for example, and
another with10 Human Resour ces car ds
and five Capit al Goods ca r ds.Just ma ke
sure each set includes a total of 15 car ds.
5.
Enough copies ofActivity 10.4 (10 Econo
ca r ds) for halfthe studentsin t he class.
You will to cut these car ds apart,but
dont need tobe put intoset s. Econos
willbe distributedduringthe simulation
,
so you can putthem in an envelope or con-
t ai ner to ma ke iteasy t ogive them out .
6. A copy of Act ivit y 10.5 and Acti vit y 10. 6
for each student
7. Alarge piece ofpaperon which you have
written ECONO FACTORY
8. Masking t ape or straight pins so t hest u-
dent s ca n wearthe Business Badges
9. (Optional)Twos ma ll prizes
PROCEDURE
1. Expl ain to the students thatpeople partic-
ipa te in t he economy in a variet y ofways.
People make deci ions as cons umer s when
theypurchase goods andservices .They
make decisions as producer s when t hey
provide humanandnaturalr esources they
own to bu ine sses or when theirsavings
allow busi nesses to borrowto make i nvest-
ments in capit al goods. They also make
decisions as cit izen s,especially as vot er s,
that influence the economicdecisions
made collectively in t he economy.
2. Explain t hat the classwill engagein a sim-
ul ation called"Econoland"to learnabout
theinterrela t ionships between households
andbusinessesin a market economy.
3. Give eachstudenta copy ofActivi ty 10.1.
In struct thest udentst or ead "Overview."
Review t her ole ofhous ehol ds, t he t hree
categor ies ofproductive resources and t he
roles of busi ness fir ms. Ans wer any ques-
tions aboutthe conce ptsinvolved.
4. Di vide the class in half. Student s in one
gr oup will r epresentbusiness firms and
students in the ot he r group will represent
households. Give eachbusi ness firm 10
$100 bills anda Business Badge t owear
duringt he simula t ion.Have business
firms tape or pin their badges t otheir
shirtsto make them morer ecognizabl e to
thehouseholds.Give each householda set
of 15 resources cards.
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ATIO:-': ALCOUNCIL ON ECONOMIC EDUCATION,NEWYORK. N.Y.
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THE CIRCULAR FLOWOF ECONOMICACTIVITY- LESSON 10
5. Have t he studentsreadthe instructions
for the"Econoland" simulation on thesec-
ond pa ge of Activity 10.1. Makesure
householdsknow theymu st sellt heir
re sourcescards for moneyandthen use
the moneyto buy Econos,which represent
products. Make surebusinessesknow they
mustpaymoneyfor theresourcescards
and thensell Econos to thehouseholds.
6. Tape the ECONO FACTORYsignin the
place wherefirms willexchange three
cards- one Nat ur al Resour ces,one
~ u m n Resources andone Capit al Goods
- for one Econo. Remindthe studentsthat
Econos representgoods and services busi-
nesses sell to households.You or a student
you selectwill staffthe EconoFactory.
7. R view theinstructions for the simulation
and answer anyquestions. Re mind the
students thatth e goalofeachbusiness
firm is to endthesimulationwit h as much
money as possible. Businesses mustpay
money to obtain the product ive-r esources
cards.Thegoal ofeach householdis to end
wi th as many Econos as possible.
Households mu s t sell their re sources car ds
for mon ey,andthey ma ybuy only Econos
with money.
8. Conduct the simulat ion.Allow the stu-
dents up to 20 minutes to engage in their
exchange activities (they usuallyfinish in
15 minutes or less). When you observe
thatabouthalfthehouseholds havesold
all theirresourc s cards,announce that
exchangeswill endin five minutes.
Studentsmustknow in advance whenthe
exchange periodwill endso theycan plan
for theorderly sale oftheirremaining pro-
ductive resourcesandEconos. (Some
households mighttryto circumventthe
business process by bringingresources
cards directly to the Econo Factory.
Explain thattheylacka BusinessBadge
and thereforecannotproduce Econos. If a
st udent is staffingthe Econo Factory,
make sure thestudentis awareofthis
possibilityandknows how to respond. )
9. After thesimulationends andthe stu-
dentshave returned to theirseats, ask
themhow welltheydid:Which household
obtainedthe mostgoods and services
(Econos) duringthe simulation?Which
businessfirm now has themost money?
(Opti o n a l) Provi de a small prize to the
household with the most Econos andto
thebusinesswith the most money.
10. ProjectVisual 10.1. Explain thatthe dia-
gramshows the circularflow ofproductive
resources (factors ofproduction), goods
andservices (products) and money pay-
ments.Ask the st udent s to' describehow
households andbusinesses are interdepen-
dent.Ask t hem t orelate thecircular -flow
diagram on Visual 10.1 to t he "Econoland"
simula tion. Students who represen t ed
businesses acquired product ive
resources (human-resources, natural-
resources and capital-goods cards)
from households through the Resource
Marke t in exchange for money-income
p ay men ts . Businesses exchanged
resources cards for Econos, which rep-
resent goods and se rvices. Businesses
sol d Econos to households through the
Product Ma.rhet in exchange f or
money payments.
11. Distr ibute a copy of Acti vity 10.5 to each
st udent. Tell the students to answer
Quest ions 1, 2 and 3 usingtheinforma-
tiontheygained from thesimulationand
from Visual 10.1 (reproduced atthetop of
Activity 10.5). Discuss theiranswer to
thequestions.
1. According to thediagram,in which
markets do businesses give money-income
payments to households in exchange for
theirproduct ive resources'? Resource
markets
2. I nwhich marketsdohouseholds give
money payments to businesses in
exchangefor goods andservices? Prod uct
mar/lets
3. What did Econos representin the
simulation? Goo ds and servi ces busi-
nesses sell to households
ECONmlICS IN ACTION. C NATIONAL COUNCIL ON sco x oxnc Im UCATIo N. ' EWv ou, NY.
LESSON 10 THE CIRCU ARFLOWOF ECONOMICACTIVITY
12. Project Visual 10. 2, and as k the students
t ocompare this di agram with the di agr am
onActivity 10.5. Discuss all theways the
circular-flow mod el was alte r ed to incorpo-
ratethe governmentsector and suggest
thateven more changes woul d have to be
madeto thechar t if we wer e to incor po-
r at e international-t r ad e r elationships.
13.DistributeActivity 10.6 and not e thatthe
circul ar -flow diagramfr om Visual 10.2 is
re produced at thet op. Ins t r uct thest u-
dents to answer Questi ons 1,2, 3and 4
usingthe informati on onAct ivit y 10.6.
Discuss the answers .
1. Give an exa mple ofa produ tive
r esourcethathouseholds sell to govern-
ment.Ansu ers uiil l oary and include
teachers toorleing in public sc hools..
2. Give an exa mple ofa goodor ser vice
thatbusinesses sell togover nment .
Answers will va ry and include com-
put ers, comm u n i ca t ions s ate ll i tes,
accounting seru ices and ai rpl an es . .
3. Give an exa mple of a good or servi ce
that governmentprovides to households
in exchange for moneypayments, mainly
taxes.Answers will va ry and include
school s. p oli ce and l i re departments,
roads and librari es .
4. Give an exa mple ofa good or service
thatgovernment provi des to businesse in
exchangefor money payme nts . Answers
wi ll vary and in cl ud e poli ce, high-
ways, air-tra ffic control se rvices and
disast er ass is ta nce.
Not e: Transfer payments are government
payments for which r ecipi ents donot cur -
rently perfor m product ive serv ices.
Significantt rans fer payments in th e
UnitedStat es t oday include Social
Securitybenefits,Medicar e andMedi caid,
government-employee retirementbenefits,
unemploymentcompensationandpublic
assistancesu ch as food stamps.
CLOSURE
Explain t othe class t hatthe U.S .economy is
organi zed around a system ofprivate markets
in which pricesfor goods and services are
determinedby theinteracti on ofbuyers and
selle rs.This for m ofeconomicacti vit y creates
a t ype ofinterdependencebetweenpeople in
househol ds andpeople in businesses. Ask:
1. How doindividuals andfa milies in house-
holds dependon peopl e in bu sinesses?
People in hou seholds buy t h e goods
and services t hey des i re from business-
es. They sell t he p roductive resou rces
t h ey OWIl to businesses to earn in come.
2. How dobusinesses depend on individuals
and famili es in households?
Businesses sell goods and se rvices to
households to earn re venue and make
a profit . They p u rchase product ive
resources fr om households to produce
th e goods and servi ces consumers
d esire.
3. What is therole ofgovernment in the cir -
cul ar flow ofeconomicact ivity?
Gove rnment taxes businesses and
h ou seh olds to pay for t he p rod ucti ve
resources i t uses t o provide certain
hinds of goods a nd services t o house-
holds and businesses.
scosoxnos I N ACTION, C NATI ONAL COUNCI L ON O N o ~ n EDUCATION, NEW YORK. K Y.
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THE CmCULARFLOWOF ECONOMICACTIVITY- LESSON 10
VISUAL 10.1
THE CIRCULAR FLOWOF PRODUCTIVE RESOURCES,
GOODSANDSERVICESANDMONEYPAYMENTS
MoneyPayments
Go odsa nd Services
PRODUCT ARKETS
USEHOLDS
RESOURC MARKETS
Prod uct ive Resour ces
Money-I ncome Payments ...-........-
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LESSON 10 - THECIRCULAR FLOWOF ECONOMIC ACTIVITY
VISUAL 10.2
GOVERNMENT IN THE CIRCULAR FLOW
Money Payments
Goods andServices
PRODUCT MARKETS
HOUSEHOLDS GOVERNMENT BUSINESSES
ProductiveResources
RESOURCE MARKETS
Money-Income Payments
-,
..........
..... _ ......
Money
Payments
(Taxes)
Government
Goods and
Services
l\Ioney
Payments
(Taxes)
Government
Goods and -_-.
Services
Productive
Resources
Money-
Income
Payment s
Money
Payments
Goods and
Services
ECONOMICSINACTION, C NATIONALCOUNCIL ON ECONOMIC EDUCAT10N,NEWYORK.KY.
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THE CIRCULARFLOWOF ECONOMICACTIVITY - LESSON 10
ACTIVITY 10.1
EARNINGA LIVINGINECONOLAND
OVERVIEW
Th e Rol e s of Househ olds(I ndividualsandFamilies)
I ndividuals function as bothconsumers andproducers.In the U.S. economy,households actas
consumerswhen they buy goods andservices thatbusinesses pr oduce.Th ese exchanges take
placein product markets. Buyingfood ata localgrocerystore is an exchange in a pr oductmarket.
As r esource owners, individualsfunctionas producersby supplying productive r esources to busi-
nesses, which use these re sources to produce goods and services. These exchanges t ake placein
resource markets (also calle d factor, productiue-resource or input markets). Examples oftransac-
tions that occurin resource markets arebusinesses payingwages toworker s,r entto landowners
or interest on loans for plant andequipment.
Bus ine sses use three cat egories ofproductiveresources to produce goods andservices: human
l' source .naturalre sources andcapital.
Humanr esourcesare thenumberofpeople av ailablefor work andthe skills andmotiva-
ti on ofthese in dividual s. Businesses paywages ':J.i16 salaries to households for theirlabor
services. Entrepreneurship refers to a special t ype ofhumanre source t hat as sumes t herisk
oforgani zingother r esources to producegoods and services .The paymentto entrepr eneurs
is calledprofit.
Natural resources are gifts ofnature. These includeundeveloped land,oceans and rivers,
for ests.oil andmineral deposits,andclimacticconditions.
Capital refer s to the manufactured or constructed it ems thatbusinesses us ein theproduc-
tion proc ess. These items includebuildings, machineryand equipment. (In everydayspeech,
people commonlyr eferto money as capital;butin economics, thetermcapital r efer s to the
realproductive resources usedto produce othergoods and services .)
The Roles of Business Firms
Like households, bu sinesses fun ctionas bothconsume rs andproducers.Businesses supply goods
andservices in the product market.They arethe buyer s,or consumers,oftheproductive
r esources (humanre sources,naturalr esources andcapital r esources) used to produce goods and
services. Businesses tryto sell theirproductsfor more thant heir costsofproduction,thereby
earning a profit. If a business is not successful,it willincurlosses. In orderto earna profit ,busi-
nesses mu stsupply products thathouseholds wantto buy andsupplythese products atcompeti-
tiv e prices. If a business doesn't produce whathouseholds wantto buy, or ifit doesn't keep it s
costs ofproduction low enough to competewith other producers, it will incur loss es. A firm will
event ually gooutofbusinessifit continues to incurlosses.
l :-: .\ CTION, 0 NATIONAL COUNCIL ON ECONOMIC EDUCATION. NEW YORK. NY. 91
LESSON 10 - THE CIRCULAR FLOW OF ECONOMI C ACTIVITY
ACTIVITY 10. 1, continued
EARNING A LIVING IN ECONOLAND
INSTRUCTIONS FOR THE ECONOLAND SIMULATION
I n thissimulation, you will play therol e ofeithera householdor a business. Read carefully
about bot h roles. Thenyour teacher ill assign yourrole.
Households:
Your fir stgoal is to sell to businessesthehu manresources, natur al resources andcapital goods
t he y use to produce a product. Then,withtheincome you earnfrom sellingthoseproductive
r esources,you will purchasefrom businesses t he goods and servicesyour household wants to con-
sume.I n t his simulation, these goods andservices arecalled Econos.Your success as a household
will be me asuredby thenumberof Econos you accumulate.You will be given 15 Productive
Resour ce card s.You maynot wa nt to sell all yourresourcesimmediately because theirprices may
change as the ga me goes on. In general,however, the moreresourcesyou sell, themore money
you will earn to acquire Econos.Be sureto sell all you r resourcecardsbefore the activityends,
because at theend oft he simul ation, only the Econos you have will count.
Bu sines Firms:
Your goal is to ea rna profit by supplyi ng thegoods andse rvices households want.In this act ivity,
the only products hou seholds want t o buy are Econos. Toproduce one Econo, you mu st acquir e
one unit ofhuman resources. one unit ofnatural resources and one unit of capit al goods. You
mustb y th ese r esourcesfrom househol ds att he bestprice you cannegotiat e. Once you have
accumulated one unitofeac h re source,you may turnthesetofthree cards inatthe Econo
Factor y, which will produceone Econofor you .You arethenfr e to ell the Econot o any house-
hold for thebest priceyou can negotiate.Toearna profit, you mustsell the Econo for more than
yourcost s of product ion,which in t his ga me include the wages andsalariespaid for theuseof
humanre sou rces, the rentpaid for theuseof naturalresources and theinterestpaidfor theuse
ofcapital.Youcan then use the money you rec eive to buy more productive res ources in orderto
produce and sell more Econos. You have $1,000 to startthe game. Your business success will be
measuredby the doll ars you haveattheend ofthe activity. Try to sell allyour Econos by theend
of the activity. If you runoutof moneyand haveno Econos to sell, announce publiclyt hat you are
bankrupt andre turnto yourseat.
A Word about Prici ng:
Youwill use only $100bill s in this activity. It is possible to arrive atpricesotherthan $100,
$200, $300, etc .,by combiningsever alitems in a single transaction.Forexample, two Productive
Resources cardscouldbe sold for $300, whichis t he equivalentof $150 each. Fivecardscouldbe
sold for $300,whichis the equivalentof$60 each. However, you mustagreeon a price for which
anexchangecantakeplace usingthedenominationsof money providedin thesimulation.The
suggestedpricerangefor ProductiveResour ces cardsis $50 to $300, butanyprice thatbuyers
andsellers agreeto and cancomplete using$100 bills is acceptable.
ECONOMICS IN ACTION, c NATIONALCOUNCIL010< ECONOMIC EUUCATIO:-<. NEWYORK NY
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THE CIRCULARFLOWOF ECONOMICACTIVITY- LESSON 10
ACTIVITY 10.2
BUSINESS BADGEANDMONEY
100 100
BUSINESS
1:-; ACTIOX. XATIONAL COU:-rCIL ON ECOXo\lIC YORK. S.Y. 93
LESSON 10 - THE CIRCULAR FLOW OF ECONOMICACTIVITY
ACTIVITY 10.3
HOUSEHOLD CARDS
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THE CIRCULAR FLOWOF ECO OMICACTMTY - LESSON 10
ACTIVITY 10.4
ECONO CARDS
1 1
1 1
1 1
1 1
1 1
1 1
1 1
1 1
1 1
1 1
o
o
PRODUCT
PRODUCT
PRODUCT
PRODUCT
PRODUCT
FINISHED
1
1
1
1 .
1
1
1
1
1
E
1
1
1
1
1
1
1
1
1
1
o
o
o
PRODUCT
PRODUCT
PRODUCT
PRODUCT
PRODUCT
Eco:-;mll CS II' ,\ CTIO:\. NATIONAL COUNCIL ON N O ~ I l EDUCATION. NEWYOltK. NY. 95
LESSON 10 - THE CIRCULAR FLOW OF ECONOMICACTIVITY
ACTIVITY 10.5
THE CIRCULARFLOWOFPRODUCTIVE RESOURCES,
GOODSAND SERVICESANDMONEYPAYMENTS
Mo ney Payments
GoodsandServices
PRODUCT MARKETS
HOUSEHOLDS
RESOURCE MARK TS
Prod uctive Resources
Mon ey-I ncome Payments .. .........
1. Accordingto the diagram,inwhich marketsdo businessesgive money-incomepaymentsto
householdsinexchangefor theirproductiveresources?
2.
Inwhichmarketsdo householdsgive moneypayments to businessesinexchangefor goods
andservices?
3.
Whatdid Econos representin thesimulation?
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THE CIRCULAR FLOWOF ECONOMICACTIVI TY- LESSON 10

Services
Mo ney
P a yment s
RESOURCE MARKETS
P r od uct ive Resour ces
Money-Income Payme nt s .......--
1. Gi ve an example ofa productiver esourcethathouseholds sellt ogovernment,
2. Gi ve an exa mple of a good or service thatbusinesses sell to government,
3. Give anexample of a good or service t hatgovernmentprovides t o households in exchange for
money payments, mainlyt axes.
4. Gi ve anexample of a good or service t hatgovernmentprovides to bu sinessesin exchange for
money payments.
ECOt\ OMI C8 IN ACTfO:" " NATIONAL couxc n . ON LDUCATI01\ ' , i\'EWYORK, :\ Y. 97