FACTORS OF
PRODUCTION
The Circular Flow of a Market Economy — LESSON 2
THE CIRCULAR FLOW OF A
MARKET ECONOMY
Overview
This lesson introduces a graphic organizer, the Circular Flow Model of
a Market Economy.The graphic model illustrates the relationships of a
market economy’s sectors and markets.The model is composed of four
primary components:
■ Producer Sector
■ Consumer Sector
■ Product Markets (Goods and Services)
■ Resource Markets (Factors of Production)
The Circular Flow
of a Market Economy
PRODUCT MARKETS
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Factors of Production
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The teacher will first introduce students to the Circular Flow Model of
a Market Economy—how it is set up, how it works, what forces impact
what. Students will then participate in an activity to identify pictures
and drawings that represent the sectors and markets that make up the
model.They will use their pictures to explain how the model represents
both producers and consumers and the Product and Resource Markets.
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Producer
Sector
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This model will be helpful as an illustration when used in conjunction
with other activities illustrating market dynamics.
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E D U C AT I O N
The Teacher Page: Explaining the Circular Flow of a Market Economy found
at the end of this lesson provides a description of the model and how it illustrates
a market economy.
Objectives
The students will:
■ Identify the Producer and Consumer Sectors and the Product and Resource
Markets of the Circular Flow Model.
(Ohio Grade Six Citizenship Learning Outcome #12)
■ Explain how the Circular Flow Model illustrates the relationships of producers
and consumers in a market economy.
(Ohio Grade Six Citizenship Learning Outcome #13)
■ Explain how the Circular Flow Model illustrates the relationships of Product
and Resource Markets in a market economy.
(Ohio Grade Six Citizenship Learning Outcome #12)
■ Explain how money is used as a medium to facilitate exchanges in a market
economy.
49
LESSON 2 — The Circular Flow of a Market Economy
Student Learning Statements
■
The Circular Flow Model illustrates the relationship between the Producer
Sector and the Consumer Sector and the relationship between the Product and
Resource Markets in a market economy.
■
Producers purchase and use the factors of production to create goods and
services to sell to consumers.
■
Consumers purchase goods and services from producers and use the goods
and services to satisfy their wants.
■
Using money for exchanges makes buying and selling resources, goods and
services easier and faster.
Vocabulary
Circular Flow Model
■
Circular Flow Model: A graphic representation of the relationships of the
Producer and Consumer Sectors and the Product and Resource Markets in a
market economy.
■
Consumer: A person whose want is satisfied by using or buying a good or
service.
■
Consumer Sector: Activities in the economy that involve ownership of
factors of production by individuals or involve consuming goods and services
to satisfy wants.
■
Consumer Purchases: Payments by consumers for goods and services.
■
Factor Payments: Income received by selling the factors of production, or
“productive resources.” Rent is the payment for the land factor of production.
A wage is the payment for labor. Interest is the payment for capital. Profit is the
payment for entrepreneurship.
■
Factors of Production: Land resources (natural), labor resources (human),
capital goods (physical capital) or entrepreneurial resources available to
produce goods and services. Also called “productive resources.”
■
Goods and Services: A good is an object that can be used to satisfy a
person’s want. A service is an action that can be used to satisfy a person’s want.
■
Market Economy: An economic system where producer and consumer
decisions are primarily determined by the forces of supply and demand.
■
Producer: A person or business using factors of production to produce goods
and services.
Consumer
Consumer Sector
Consumer Purchases
Factor Payments
Factors of Production
Goods and Services
Market Economy
Producer
Producer Sector
Product Markets
Resource Markets
50
The Circular Flow of a Market Economy — LESSON 2
■
Producer Sector: Those activities in the economy involving purchasing
productive resources or producing goods and services.
■
Product Markets (Goods and Services): Whenever producers sell goods
and services to consumers in exchange for consumer purchases.
■
Resource Markets (Factors of Production): Whenever resource
owners (consumers) sell factors of production to producers in exchange
for factor payments.
Materials
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Student Page:The Circular Flow of a Market Economy (transparency)
Teacher Page: Explaining the Circular Flow of a Market Economy
A variety of periodicals or newspapers with pictures of various kinds of
resources (factors of production), goods and services
■ Large pieces of butcher or construction paper for each pair of students
Producing Ohio Video Connections
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Factors of Production (Southwest Local Schools)
Markets & Prices (Ohio Farm Bureau, the Ohio corn industry)
Internet Resources
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http://www.quia.com/jw/13122.html
http://vcsd.neric.org/distancelearning/Ch29notes/tsld002.htm
http://www.amosweb.com/cgi-bin/gls_dsp.pl?term=factors+of+production
http://www.cfee.org/en/rescanec.shtml
http://www.uri.edu/artsci/newecn/Classes/Art/INT1/Mac/Intro/Circflow.html
http://price.bus.okstate.edu/archive/econ2023/exam1/key3.htm
http://www.economics101.org/ch25/ch25-macro6/
http://www.economicsintl.org/pubs/lessons/kristfiles/KRIST.html
http://www.southwestschools.org/
http://www.ofbf.org/ofbweb/ofbwebengine.nsf/homepage
Prepare
■
Duplicate Student Page:The Circular Flow of a Market Economy (one per student).
51
LESSON 2 — The Circular Flow of a Market Economy
Introduce
1. Begin by asking students, “What does an economy look like?” Responses will
vary. Elicit students’ images of economic activity and markets. Ask probing
questions that help the students to suggest consumers, producers, resources
and goods and services. Students may also suggest factories, offices and stores.
Teach
Circular Flow Model:
A graphic representation
of the relationships
of the Producer and
Consumer Sectors
and the Product and
Resource Markets in
a market economy.
2. Distribute copies of or project the transparency of the Student Page:The Circular
Flow of a Market Economy. Introduce the “Circular Flow Model” as a picture of
what a “market economy”—like the United States’ economy—looks like.
3. Review the four major components of the Circular Flow Model. See the
Teacher Page: Explaining the Circular Flow of a Market Economy for information
about the model’s components: the “Producer Sector,” “Consumer Sector,”
“Product Markets” (goods and services) and “Resource Markets” (factors of
production).
Market Economy:
An economic system
where producer and
consumer decisions are
primarily determined by
the forces of supply
and demand.
• Producer Sector: Those activities in the economy involving purchasing
productive resources or producing goods and services.
• Consumer Sector: Activities in the economy that involve ownership of
factors of production by individuals or involve consuming goods and services
to satisfy wants.
• Product Markets (Goods and Services): Whenever producers sell goods
and services to consumers in exchange for consumer purchases.
• Resource Markets (Factors of Production): Whenever resource owners
(consumers) sell factors of production to producers in exchange for factor
payments.
4. Explain that the model does not indicate the size, health or speed of the
economy. It shows only the relationships among the different components of
a market economy.
To know the size of an economy, you would need to know how fast the
circular flow moves.You would need to know how healthy the economy is.
When the flow moves faster, the economy grows, it’s healthier. (Point at the
model and follow the arrows around clockwise.Then move your finger or
pointer around the flow faster to indicate more economic activity.)
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The Circular Flow of a Market Economy — LESSON 2
Discuss
5. When does economic activity begin?
Economic activity begins with “consumer” wants. Production activities are concerned
with the satisfaction of those consumer wants. Economic activity begins with the
demand for a “good or service.”
Consumer:
A person whose want
is satisfied by using
or buying a good or
service.
How do people (consumers) get the things (the goods and services) they want?
People either “produce” goods themselves or purchase the things they want. In some
cases, goods and services are purchased for others or are provided by the government
to satisfy wants.
Refer to the Circular Flow Model. Point out the Goods and Services and
Consumer Purchases arrows between the Producer Sector and the Consumer
Sector.These arrows represent the flow of sales from producers and purchases
of goods and services by consumers in the Product Markets.
Goods and Services:
A good is an object
that can be used to
satisfy a person’s want.
A service is an action
that can be used to
satisfy a person’s want.
6. Where do people (consumers) get income (money) to purchase the goods and
services they want?
Students will mention jobs or other forms of income.When defining income, or
“factor payments,” include transfer payments—government programs (unemployment,
disability), retirement pay, dividends and interest, etc.
Producer:
A person or business
using factors of
production to produce
goods and services.
Explain that money is used to facilitate exchanges in a market economy.
People use their income to purchase goods and services—to make “consumer
purchases.” (Point out the Land, Labor, Capital, Entrepreneurship and Factor
Payments arrows between the Consumer Sector and the Producer Sector on
the model.These arrows represent the purchases of “factors of production”
by producers and the income received by consumers for those factors in the
Resource Markets.)
Factor Payments: Income received by selling the factors of production, or
“productive resources.” Rent is the payment for the land factor of production.
A wage is the payment for labor. Interest is the payment for capital. Profit is the
payment for entrepreneurship.
Consumer Purchases: Payments by consumers for goods and services.
Factors of Production: Land resources (natural), labor resources (human),
capital goods (physical capital) or entrepreneurial resources available to
produce goods and services. Also called “productive resources.”
53
LESSON 2 — The Circular Flow of a Market Economy
Teach
7. Explain that people purchase goods and services in the Product Markets
with income (money) they earn by selling their resources to producers in
the Resource Markets.The circular flow is a continuous process. Follow
the arrows around the model—from the Consumer to the Producer to the
Consumer Sector.
• The inside arrows of the Circular Flow Model—Consumer Purchases and
Factor Payments—represent the flow of money that people use to make
transactions. Explain that these money flows move in the opposite direction
from the Goods and Services and the Land, Labor, Capital, Entrepreneurship
(factors of production) flows.
• Money flow is a continuous process. As long as businesses are buying
resources and selling goods and services, the flow moves. (Point to the inside
money flows, the Consumer Purchases and Factor Payments arrows. Follow
the arrows to indicate how income is earned and then spent to purchase
goods and services.)
The Circular Flow
of a Market Economy
PRODUCT MARKETS
nd Servic
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RESOURCE MARKETS
Factors of Production
8. Review the Circular Flow Model. Students should understand that:
• People sell their resources to earn income.
• People use their income to buy goods and services from producers.
• As people earn more income, they buy more goods and services.
54
The Circular Flow of a Market Economy — LESSON 2
Conclude
■
9. Review:
• Resources are exchanged in the Resource Markets, with producers buying
factors of production from consumers.
• Goods and services are exchanged when producers sell them to consumers
in the Product Markets.
■
■
■
■
Resources
are exchanged
in the Resource
Markets, with
producers
buying factors
of production
from consumers.
10. Divide the class into small groups. Give each group a large piece of butcher or
construction paper. Direct the groups to use the periodicals and newspapers to
find pictures to make their own Circular Flow Models.
Students should draw the outline of the Circular Flow Model.They should
then place appropriate pictures and/or drawings to represent the sectors and
markets in the model.
Examples:
• Pictures of trees, land, water, crops and other natural resources would
represent Land Resources.
• Pictures of workers/people who might be workers can represent Labor
Resources.
• Pictures of machines, tools, equipment, factories and/or businesses can
represent Capital Resources.
• A picture of Entrepreneurship may be a “help wanted” advertisement or
a business’ “grand opening” announcement.
• A picture of someone buying something can represent Consumer Purchases.
■
Assess
■
■
■
■
Goods and
services are
exchanged
when producers
sell them to
consumers in
the Product
Markets.
11. Student groups should display their Circular Flow Models. Have them explain
how the pictures they have selected represent the four factors of production,
goods and services, consumer purchases, factor payments, producers and
consumers.Through their examples, they should be able to describe the factors
of production accurately and define goods and services.
Connect: Expanding the Learnings
LANGUAGE ARTS
In a written essay, students explain how the Circular Flow Model works. Have
students use a good or service as an example. Use the prompt: “In a market
economy, the production of _______________________________
begins with . . .”
(good or service)
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STUDENT PAGE
LESSON 2 — The Circular Flow of a Market Economy
The Circular Flow
of a Market Economy
PRODUCT MARKETS
nd Servic
ods a
es
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Capital En
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CINCINNATI
Factors of Production
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E C O N O M I C
E D U C AT I O N
56
The Circular Flow of a Market Economy — LESSON 2
TEACHER PAGE
Explaining the Circular Flow
of a Market Economy
In the Circular Flow Model:
■ All resources are owned by the Consumer Sector. “Consumer” is the term
used to represent units of consumption and resource ownership. A consumer
may be a single person, a family, some number of individuals or any other
organized group that consumes together.
■ These individuals and groups sell their resources (their factors of production)
to the Producer Sector. “Producer” includes any unit of production—a single
person, a small or large business or a group of people. Producers are also
resource buyers.
The key to understanding the Circular Flow Model is understanding the relationship
between the Factors of Production in the Resource Markets and the Goods
and Services in the Product Markets.
■ The process begins with the demand for a good or service.
■ The producer—with the expectation of making a profit—purchases land, labor
and capital resources from consumers in the Resource Markets.
■ The producer, or decision maker, provides the entrepreneurial decisions about
what goods and services to produce and how to produce them.
■ The factors of production are transformed (produced) into goods and services
in the Producer Sector and sold to consumers in the Product Markets.
The real flow of economic activity moves clockwise around the Circular Flow
Model. An inner flow of money—Factor Payments and Consumer Purchases
—exists in order to keep the flow of economic activity moving.
■ Money is used as a medium of exchange in the markets.
■ In the Resource Markets, the money flows are the payments for the different
types of factors of production: rent for land, wages for labor, interest for capital
and profit for entrepreneurship.
■ These factor payments (income) go to consumers.The income is then used by
consumers to demand (and pay for) goods and services in the Product Markets.
Note: The Circular Flow Model does not indicate the size, health or speed of
a market economy. It only represents the relationships among the different sectors
and markets.To indicate the dynamics or pace at which the flows occur, use a hand
gesture moving clockwise around the model, increasing the speed to simulate more
economic activity.
57