Lesson 10 - The Circular Flow of Economic Activity
IN
ODUCTION
Ec o nom ics
The circular fl ow of econ om ic acti vity is a sim­
plified macroecon omi c model of the ba sic eco­
nomic relationships in a market economy. This
mod el gives the st udents a n overview of h ow
households, busines ses a nd government inter­
a ct in different ma rkets by excha nging goods
and services, pr oductive resources (also known
as inputs or the factors of producti on) and
mo ney.
Reasoning
P eople r espond to incentives . Households have
incentives to pr ovide resources to busines ses to
receive inc ome in r etur n . Th ey then have
in cen t ives to use t heir income to purchas e
goods a nd services to sa tisfy their wants.
Busines ses hav e in cen t ives to ea rn pr ofits a nd,
therefor e, to produce the goods a n d services
that consumer s wa n t. To produce goods and
services, businesses need to purchase
re sources from ho useholds. The cir cul ar -flow
mod el and the simulation in this lesson
demonstrate these impor t a nt r elation ships .
CONCEPTS
Circula r flow of goods, services, productive
resources and money payments
Inter dependence
Productive r esources
(na tural, human and capital)
Resou rce payments
(wages and salaries, r ent, interest, profit)
CONTENT STANDARDS
7. Mar kets exist when buyers and seller s
interact . Th is interaction determines mar­
ket pri ces and thereby alloca te s scarce
goods and serv ices .
16 . Ther e is an economic rol e for government
to play in a market economy whenever the
benefits of a govern men t policy ou twe igh
its costs. Gover n men ts often provide for
nati onal defense, address environ men ta l
concerns , define and protect prop erty
r igh ts, and a tte mpt to ma ke markets more
comp etiti ve. Most government policie s al so
redi stribute income.
18. A nation's overall levels of income, emp loy­
ment a nd prices are det ermined by the
interaction of sp ending and production
deci sions made by all households, firms ,
government ag encies and others in the
economy.
OBJECTIVES
Stu dents will
1. Identify and describe th e three types of
productive resources (inputs) and the kind
of income each resource earns.
2. Analyze the economic relationship s
between households and businesses in a
market economy.
3. Use a circular-flow diagram to illustrate
the economic relationships among house­
holds, businesses and government.
ECON<1:Ill CS IN ACTION, 'Q NATIONAL COL:-:CIL m~
~; C O ~ O M I C
EDUCATION, NEW YORK, NY
Sf
. LE SSON 10 - THE CIR CULAR FLOW OF ECONOMIC ACTIVITY
LESSON DESCRIPTION
In this lesson, the st uden ts read about market
int er acti ons and participate in a si m ula tion .
"Econola nd" involves transactio ns between
bu sinesses and households in tv 0 kinds of
~ ar1( et s: product ma rkets and resource (or
in put) marke t s. They discuss h ow the govern­
ment fit s in to this mode l a nd tra nsla te their
conclusions int o a circula r -flow diagr a m.
6. A copy of Act ivity 10.5 a nd Acti vit y 10.6
for eac h stu dent
7. A large piece of pa per on which you ha ve
written ECON O FACTORY
8. Masking t ap e or straigh t pins so t he stu­
den ts ca n wear the Bu siness Badges
TIME REQUIRED
7fj minut es: 45 mi nu tes to conduc t a nd discuss
th e simula t ion a nd 30 minutes t o comple te
. ct ivit ies 10.5 and 10.6
MATERIALS
Note : Prepare material s for t he simu la ti on
before cla ss, mainly cutting ap art activity
sh eets a nd cr eating sets of ma ter ials for th e
students. If possible, lami na te badges, car ds
a nd mon ey to use in mul tip le classes .
I . Visu als 10.1 a nd 10.2
2. A copy of Act ivity 10.1 (two pages) for each
student
3. Enou gh copies of Act ivity 10.2 (one
Bu siness Badge a nd 10 $100 bill s) for h alf
th e st ud ents in the class . These students
will represe nt bu sinesses .
4. E nough copies of Act ivity 10.3 (five
H u ma n Resources ca r ds, five N atu r al
Resou rces' cards a n d five Ca pit al Goods
ca rds) for the r est of the st u de n ts in the
clas s, wh o will r epresen t hou seholds. Mix
t h e se ts up so th e cards a re not distr ib­
u t ed equally: Ma ke one set with 15
N atural Resources ca r ds, for ex ample, an d
a nother with 10 Hu ma n Resou r ces car ds
a nd five Capit al Goods ca r ds . Ju st ma ke
su re each set inclu des a total of 15 car ds .
5. Enough copies of Activity 10.4 (10 Econ o
ca r ds) for half the students in th e class.
You will ~ee d to cu t these car ds apart, bu t
t~ey don t n eed to be put into sets. Econos
will be distributed during the simulation ,
6
so you ca n put them in a n envelope or con ­
t ai ner to ma ke it ea sy t o give them out .
9.
(Optional) Two s ma ll prizes
PROCEDURE
1. Expl ain to the studen ts that people pa rtic­
ipa te in the econo my in a va riet y of ways .
P eople make deci ion s as cons u me r s wh en
they pu rchase goods and se rvices . They
ma ke decisio ns as produ cer s when t hey
provide hum an and natural r esources they
own to bu ine sses or when their sa vings
allow busi nesses to borrow to ma ke invest ­
ments in capit al goods. They a lso m ake
decisions as cit izen s , especially a s vot er s,
tha t in flu ence the economic decisions
mad e colle ctively in t he econo my.
2. Explain t hat th e class will engage in a sim­
ul ation called "Econoland" to learn about
the interrela tionships between households
an d businesses in a market economy.
3. Give each student a copy of Activi ty 10.1.
In struct the st udents t o r ea d "Overview."
Re view th e r ole of h ous ehol ds, th e t hree
ca tego r ies of productive resources a nd t he
roles of busi ness fir ms. Ans wer a ny qu es­
tions ab out th e conce pts in volved.
4. Divide the class in half. Stu de nt s in on e
gr ou p will r epresent business firm s and
stu dents in the ot he r group will represent
h ouseholds. Giv e each business fir m 10
$100 bills a nd a Business Badge t o wear
during t he simu la t ion . Have bu siness
firms tape or pin their badges t o their
shirts to make them more r ecognizable to
the households. Give each household a se t
of 15 resources cards.
ECONO:\lI CS IN ACTION • e NATIO:-':AL
'
COUN CIL ON ECONOMIC ED UCATION, N EW YORK. N. Y.
TH E CIRCULAR FLOW OF ECO NOMIC ACTIVITY - LE SS ON 10
5. Have the students read the instructions
for the "Econoland" simulation on the sec­
ond pa ge of Activity 10.1. Make sure
households know they mu st sell t heir
re sources cards for money and then use
the money to buy Econo s, wh ich represent
products. Make sure businesses know they
must pay money for the resources cards
and then sell Econos to the households.
9. After the simulation ends and the stu­
6. Tape the E CONO FACTORY sign in the
place where firms will exchange three
cards - one Na tur al Resour ces , one
~Human Resources and one Ca pit al Goods
- for one Econo. Remind the students that
Econos represent goods and services busi­
nesses sell to households. You or a student
you select will staff the Econo Factory.
7. R view the instructions for the simulation
and a nswer any questions. Re mind the
stu dents that th e goal of each business
firm is to end the simulation wit h as much
money as possible. Businesses must pay
money to obtain the productive-r esou rces
cards. The goal of each household is to end
wi th as many Econos as possible.
Househ olds mu s t sell their re sources ca r ds
for mon ey, and they ma y b uy only Econos
with money.
10. Project Visual 10.1. Explain that the dia­
gram shows the circular flow of productive
resources (factors of production), goods
and se rvices (products) and money pay­
ments. Ask the st udents to' describe how
h ouseholds and businesses are in terdepen­
dent. A sk th em t o rela te the circular -flow
diagram on Visual 10.1 to t he "Econola nd"
simula tion. Students who rep resen ted
businesses acquired produc t ive
resources (human-resources, natural­
resources and capital-goods cards)
from households through the Resource
Marke t in excha nge for money-income
p ay m en ts . Busin es ses exchanged
res ou rce s card s for Econ os, which rep­
resent goods and se rvices. Businesses
s old E con os to households through th e
Product Ma.rhet in exchange f or
money payments.
8. Conduct the simula tion. Allow the stu­
den ts up to 20 minutes to engage in their
exchange activities (they usually finish in
15 minutes or less). When you observe
that about half the households have sold
all their resourc s cards, announce that
exchanges will end in five minutes.
Students must know in advance when the
exch a nge period will end so they can plan
for the orderly sale of their remaining pro­
ductive resources and Econos. (Some
households might try to circumvent the
business process by bringing resources
cards directly to the Econo Factory.
Explain that they lack a Business Badge
and therefore cannot produce Econos. If a
st u dent is staffing the Econo Factory,
make sure the student is aware of this
possibility and knows how to respond. )
11. Distr ib ute a copy of Acti vity 10.5 to each
stud en t. Tell the students to answer
Quest ions 1, 2 and 3 using the informa­
tion they gained fro m the simulation and
from Vis ual 10.1 (reproduced at the top of
Activity 10.5). Discuss their answer to
the qu estions.
1. According to the dia gra m, in which
markets do businesses give money-income
payments to households in excha nge for
their product ive reso urces'? Resource
markets
2. I n which markets do households give
money payments to bu sinesses in
exchange for goods and services? P ro d u c t
mar/lets
3. Wh a t did Econos represent in the
simulation? Goo d s a n d servi ces bu si­
nesses sell to hou s ehold s
dents have returned to their seats, ask
them how well they did: Which household
obtained the most goods and services
(Econos) during th e simulation? Which
business firm now h as the most money?
(O p tio n a l) Provi de a small prize to the
household with the most Econos and to
the business with the most money.
ECONmlICS IN ACTION. C NATIONAL COUNCIL ON sco x o xnc Im UCATIo N. • ' EW v ou « , NY.
LESSON 10 THE CIRCU AR F LOW OF ECONOMIC ACTIVITY
12 . Project Visual 10.2, and as k the students
t o compare this diagram with the diagr am
on Activity 10.5. Discuss all the ways the
circular-flow mod el was alte r ed to incorpo­
rate the government sector and suggest
that even more changes would h ave to be
made to the ch a r t if we wer e to inco r po­
r at e internation al-tr ad e r ela tionships.
CLOSURE
Explain t o the class that the U.S . econo my is
orga ni zed around a syste m of private markets
in which prices for goods a nd services are
determined by the interacti on of buyers and
se lle rs . This for m of econo mic acti vity creates
a t ype of interdepend en ce between people in
househol ds and people in busin esses. Ask:
13. Distribute Activity 10.6 a nd not e that the
circular -flow diagram fr om Visual 10.2 is
re produced at the t op. Ins t r uct the st u­
dents to answer Questi on s 1, 2, 3 an d 4
using the information on Act ivit y 10.6.
Discuss the answ ers .
1. Give an exa mple of a produ tive
r esource that hou seh old s se ll to govern­
ment. Ansu ers uiil l oary and include
teachers toorleing in public sc hoo ls..
2. Give a n exa mple of a good or ser vice
that businesses se ll to gover n men t.
1.
Answers will va ry and include com ­
pu ters, com m u n ica t io n s s a te ll ite s,
accountin g seru ic es and ai rpl an es . .
3. Give an exa mple of a good or servi ce
that government provides to households
in exch ange for money payments, mainly
taxes . Answers will va ry and include
sch ool s. p oli ce and l i re departments,
roads and librari es .
4. Give an exa m ple of a good or service
that government provides to businesse in
exchange for money pa yme nts . Answers
w ill vary and in cl u d e poli ce, high­
ways, air-tra ffic control se rvices and
disaster a ss is ta n ce.
How do individuals a n d fa milies in house­
hold s dep end on peopl e in bu sinesses?
People in h ou seho lds b uy t h e goods
and services they d es ire from business­
es. Th ey sell t h e p roductive resou rces
t h ey OWIl to businesses to earn in com e.
2. How do businesses depen d on in dividuals
an d famili es in h ousehold s?
Businesses sell goods and se rvices to
households to earn re venu e and m ake
a profit . They p u rchase prod uct ive
resources fr om househo lds to produce
th e goods and servi ces consumers
d esire.
3. Wh a t is the role of governm en t in the cir ­
cul a r flow of econo mic act ivity ?
Go ve rnment taxes businesses and
h ou seh olds to pay for t h e p rod u c ti ve
resources it uses to provide certain
hin d s of goods a nd s ervices to house­
h olds and businesses.
No t e : Transfer p aymen ts are government
paym ents for which r ecipi ents do not cu r ­
rently perfor m produc tive se rv ices.
Significant tra ns fer paymen ts in th e
United Sta t es t oday include Social
Security ben efits , Me dicar e and Medi caid ,
government-employee retirement benefit s,
unemployment compensation and public
assistance su ch as food stamps.
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scosoxnos I N ACTION, C NATI ONAL COUNCI L ON ECONo~n c EDUCATION , NEW YORK. K Y.
THE Cm CULAR FLOW OF ECONOMIC ACTIVITY - LESSON 10
VISUAL 10.1
THE CIRCULAR FLOW OF PRODUCTIVE RESOURCES,
GOODS AND SERVICES AND MONEY PAYMENTS
Money Payments
Go ods a n d S ervices
PRODUCT
ARKETS
USEHOLDS
RESOURC
MARKETS
Prod u c t ive Reso u r ces
Mo n ey-I n co m e Payments . . .-........­
ECONOMICS IN ACTION, C NATIONAL COUNCIL ON ECONOMIC EDUCATION, NEW YORK, N.V.
89
· LESSON 10 - THE CIR CULAR FLOW OF ECO NOMIC ACTIVITY
VISUAL 10.2
GOVERNMENT IN THE CIRCULAR FLOW
Mo n e y P a y m e n t s
Go o d s and Services
PRO DUCT M ARKETS
l\I o n ey
Payments
Mo n ey
P a y m ent s
(Tax es)
(Tax es)
Go ve r nm e n t ....._ ......
Goo d s a nd
Se r vi ce s
HOUSEH OLDS
....... . . .~ Go ve r n m e n t
Go o d s a n d - _ - .
Se r v ic es
GOVERNMENT
P r o d u c t ive
Re s o u rc e s
BUSINESSES
Go od s a n d
Ser v ic es
Money­
I n c om e
Paym e n ts
Mo n e y
P a ym e n t s
-,
RESOURCE MARKETS
Prod u ctive Resources
Mo n ey-I n c om e Payments
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ECONOMIC S IN ACTION, C NATIONAL COUNCIL ON ECONOMIC EDUCAT10 N, N EW YOR K. K Y.
THE CIRCULAR FLOW OF ECONOMIC ACTIVITY - LE SS ON 10
ACTIVITY 10.1
EARNING A LIVING IN ECO NOLAND
OVE RVIEW
T h e R ol e s o f Ho u s e h o lds (I nd ividuals and Families)
I ndividu als function as both consu me rs and producers. In th e U .S. economy, households act as
con sumers wh en th ey buy goods and services that busines ses pr oduce. Th ese exchanges take
place in product m arkets. Buying food at a local grocery store is an exch ange in a pr oduct market.
As r esource owners, individuals function as producers by s up plying productive r esources to busi­
nesses, which use these re sources to produce goods and services. These exchan ges t ake place in
resou rce m arkets (also calle d factor, productiue-resource or input markets). Exa m ples of transac­
tions th a t occur in resource markets are businesses paying wages to worker s, r ent to landowners
or interest on loans for pla nt and equip ment.
Bus ine sses use three ca t egories of productive resources to produce goods and services: huma n
source . n atural re sources and capital.
l'
Human r es ources are the number of people av ailablefor work and the skills and motiva­
ti on of these in dividual s. Businesses pay wag es ':J.i1 6 salaries to households for their labor
se rvices. En trep reneu rsh ip refers to a specia l type of human re source th a t as sumes th e risk
of orga ni zing oth er r esources to produce goods and se rvices . Th e payment to entrepr eneu rs
is ca lled profit.
Natural resource s a re gifts of nature. Th ese in clude undeveloped land, ocea ns a nd rivers,
for ests. oil and min eral deposits, and climactic conditions.
Capital refer s to the manufactured or constructed it em s that businesses us e in the produc­
tion proc ess. These items include buildings, machinery a n d equipment. (In everyday speech ,
people commonly r efer to mon ey as capital; but in economics, the term capital r efer s to the
real productive resources used to produce other goods a nd se rvices .)
The R oles of Business F irms
Like households, bu sinesses fun ction as both consu me rs and producers. Businesses su pply goods
and services in th e product market. They are the buyer s, or cons u mers, of the productive
r esou rces (human re sources , natural r esources and capital r esources) used to produce goods a nd
services. Bu sinesses try to sell their products for more than their costs of production, thereby
ea rning a profit. If a business is not s uccessful, it will in cur losse s. In order to earn a profit, busi­
ne sses mu st supply products that households want to buy and supply these products at competi­
tiv e prices. If a business doesn't produce what households want to buy, or if it doesn't keep it s
costs of production low enough to compete with other producers, it will incur loss es . A firm will
eve n t ually go out of business if it continues to incur losses.
EC O :-iO ~ I! C S
l:-: .\ CTIO N, 0 NATIO NAL COU NCIL ON ECON OMIC EDUCATIO N. NEW YORK. NY.
91
LESS ON 10 - THE CIR CULAR FLOW OF ECONOMI C ACTIVITY
ACTIVITY 10. 1, continued
EARNING A LIVING IN ECONO LAN D
INSTRU CTIONS FOR THE ECONOLAND SIMULATION
I n this simulation, you will play the rol e of either a household or a business. Rea d carefully
ab ou t bo th roles. Then your teacher ill assign your role.
Hou seholds:
Your fir st goal is to sell to businesses the h u man resources, natur al resou rces and capital goods
the y use to produce a product. Th en , with the income you earn from selling those productive
r esources, you will purchase from b usine sses t he goods and services you r household wants to con­
sume. I n t h is simulation, these goods and services are called Econos. Your success as a household
will be me asured by the number of Econ os you accumulate. You will be given 15 Productive
Resour ce ca rd s. You may not wa n t to sell all your resources immediately because their prices may
ch ange as the ga me goes on. In gen era l, however, th e more resources you sell, the more money
you will earn to acquire Econos . Be sure to sell all you r resource cards before the ac tivity ends,
beca use at the end of the simul a tion, only th e Econ os you have will count.
Bu sines Firms:
You r goal is to ea rn a profit by supplying the goods and se rvices households want. In th is ac tivity,
th e only products hou seholds wa n t to buy are Econos . To produce one Econo, you mu st acquir e
one un it of hu ma n resou rces. on e unit of natural resources a nd on e unit of ca pit a l goods . You
must b y th ese r esources from households at th e best price you can negotia te. Once you h ave
accumulated on e unit of eac h re sou rce, you may turn the set of three cards in at the Econo
Factor y, which will produce one Econ o for you . You are then fr e to ell the Econo t o a ny house­
hold for the best price you can n egotiate. To ea rn a profit, you must sell the Econo for more than
your cost s of prod uction , which in t h is ga me include the wages and salaries paid for the use of
human re sou rces, the rent paid for the use of natural resources and the interest paid for the use
of capital. You ca n th en use the mon ey you rec eive to buy more productive res ources in order to
produce and sell more Econos. You have $1,000 to start the game . You r business success will be
measured by the doll a rs you have at the end of the activity. Try to se ll all your Econ os by the end
of th e activity. If you run out of money and have no Econos to sell, announce publicly t h a t you are
ba nkrup t and re turn to your seat.
A Word ab out Pricing:
You will use only $100 bills in this activity. It is possible to arrive at prices other than $100,
$200, $300, etc ., by combining sever al items in a sin gle transaction . For example, two Productive
Resources cards could be sold for $30 0, which is t h e equivalent of $150 each. Five cards could be
sold for $300, which is the equivalent of $60 each. However, you must agree on a price for which
an exchange can take place using the denominations of money provided in the simulation. The
suggested price range for Productive Resour ces cards is $50 to $300, but any price that buyers
and sellers agree to a n d can complete using $100 bills is acceptable.
92
ECONOMICS IN ACTION, c NATIONALCOUNCIL 010< ECONOMIC EUUCATIO:-<. NEW YORK NY
THE CIRCULAR FLOW OF ECONOMIC ACTIVITY - LESSON 10
ACTIVITY 10.2
BUSINESS BADGE AND MONEY
100 100
BUSINESS
E(,O:-:O ~ Ilr:S
1:-; ACT IOX.
XAT IONAL COU:-rCIL ON ECOXo\lIC
f: DUC\T I () ~ . ~EW YORK. S.Y.
93
·LESSON 10 - THE CIRCULAR FL OW OF ECONOMIC ACTIVITY
ACTIVITY 10.3
HOUSEHOLD CARDS
94
ECO NOMI CS IN ACTI OI\ , " NATIO NAL CO UN CIL ON f:CON01\n C EDU CATION.
:--:r.'.... YORK. :--: .Y.
THE CIRCULAR FLOW OF ECO OMIC ACTMTY - LESSON 10
ACTIVITY 10.4
ECONO CARDS
1 1
1
1 .
PRODUCT
o
1
PRODUCT
1
o
1
1
1
PRODUCT
FINISHED
1
PRODUCT
1 1
1
1
o
PRODUCT
1 1
1
1
o
PRODUCT
1 1
PRODUCT
1
1
PRODUCT
Eco:-;m ll CS II' ,\ CT IO:\.
1
PRODUCT
1
NATIONAL COU NCIL ON
EC ONO ~Il C
1
1
1
1
1
1
1 1
1
1
1
o
E
1
1
1
PRODUCT
EDUCATION. NEW YOltK. N Y.
1
95
LE SSON 10 - THE CIRCULAR FLOW OF ECONOMIC ACTIVITY
ACTIVITY 10.5
THE CIRCULAR FLOW OF PRODUCTIVE RE SOUR CES,
GOODS AND SERVIC ES AND MONEY PAYMENTS
Mo n ey Payments
Goods and Services
PRODUCT MARKETS
HOUSEHOLDS
RESOURCE MAR K TS
Prod uctive Resources
Mon ey -I n c om e Payments . ._~.........
1. According to the diagram, in which markets do businesses give money-income payments to
households in exchange for their productive resources?
2. In which markets do households give money payments to businesses in exchange for goods
and services?
3. What did Econos represent in the simulation?
96
ECONOMICS IN ACTION, 0 NATIONAL COUNCIL ON ECONOMIC EDUCATIO N, NEW YORK, NY
•
THE CIR CULAR FLOW OF ECONOMIC ACTIVI TY - LESSON 10
ACTIVITY 10.6
GOVERNMENT IN THE CIRCULAR FLOW
Mo n e y Payments
Goods and Services
PRODUCT MARKETS
'.
HOUSEHOLDS
GOVERNMENT
BUSINES SE
GOOdS and
~
Services
Mo ney
P a yme n ts
RESOURCE MARKETS
P r o d u c t iv e Resour ces
Money-Incom e Pay m e n t s . . . . . . .- ­
1.
Gi ve an ex am ple of a productive r esource that households sell t o government,
2.
Gi ve an exa m ple of a good or service that businesses sell to government,
3.
Give an exa m ple of a good or s ervice t h at government provides to households in exch a n ge for
mon ey paym ents, mainly t axes.
4.
Gi ve an exa m ple of a good or s ervice t h at government provides to bu sinesses in exchan ge for
money payments .
ECOt\ OMI C8 IN ACTfO :" " NAT ION AL c oux c n . ON
ECm; O ~l!"
LD UCATI01\', i\'EW YORK, :\ Y.
97