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Chocolate Economics: Lesson 7
Lesson 7: The Circular Flow
Objectives:
•
•
•
Students will understand the circular flow of income in a market economy.
Students will be able to recognize examples of the flow of income in
children’s literature.
Students will be able to develop their own circular flow diagram for the
production of chocolate.
Discussion:
Most economics texts start with a basic model of a market economy, the circular
flow of income diagram. The circular flow diagram is a simple illustration to
show how income flows through the economy between producers and
consumers. The diagram makes it clear that consumers and producers are
interdependent. Consumers rely on producers to make goods and services
available. When consumers buy products, money flows to producers. At the
same time, producers rely on consumers to provide labor for production. When
labor is provided, people get paid and that allows them to buy goods and
services.
When using this diagram with young students, it is important to make the
diagram less abstract, substituting pictures for words and using scenarios with
which they can identify (for example, a firm like McDonalds or an item like
Pokemon cards). The activities in this lesson incorporate the circular flow
diagram at a very concrete level. However, it is important for the instructor to
first understand what the diagram is and what it illustrates.
The circular flow diagram starts with two economic decision units: the
household and the firm. These two entities capture the ideas of consumption
(household) and production (firm). [Please note that this is a bit simplified.
Realistically, firms are consumers when they purchase resources in the resource
market. For young children, however, it is easiest to think of consumers as
people and producers as firms.]
Copyright 2001; Cyndee Moore and Melanie Marks
M&M Publishing Company
Chocolate Economics: Lesson 7
58
The diagram goes on to illustrate the flow of money between the two sectors of
the economy. Consumers buy goods and services from firms, but firms pay
people for their labor. This exchange of money takes place in two different
markets: the resource market and the output market (also referred to as the
market for goods and services).
The resource market is where firms buy the materials and labor that they need to
produce their product. A firm that makes books would need to buy paper and
ink, machines to do the printing, and labor to run the machines. The firm then
converts these resources into goods that they sell in the output market.
Households, on the other hand, are also involved in these two markets.
Households provide labor to firms in the resource market. When we go to work
in the morning, we are participating in the labor market. We earn money from
the firms and this allows us to buy goods and services in the output market.
Copyright 2001; Cyndee Moore and Melanie Marks
M&M Publishing Company
59
Chocolate Economics: Lesson 7
From the firm’s perspective, the circular flow involves:
1) Purchasing resources in the resource market,
2) Using the resources to produce a good or service,
3) Selling the item to others in the output market.
This is illustrated as follows:
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Copyright 2001; Cyndee Moore and Melanie Marks
M&M Publishing Company
60
Chocolate Economics: Lesson 7
From the consumer’s perspective, the circular flow involves:
1)
Providing labor to firms through the resource market, in exchange for
money,
2)
Purchasing goods and services from firms in the output market.
This can be seen as follows:
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Copyright 2001; Cyndee Moore and Melanie Marks
M&M Publishing Company
61
Chocolate Economics: Lesson 7
When the two perspectives are combined, the diagram shows the flow of money
to moving in a circle. Firms spend money on inputs they need for production,
one of these needs being labor. Households sell labor to earn money and then
they spend it on goods and services sold by firms.
Resources
Labor
$$$$
Goods
and
Services
$$$$
Copyright 2001; Cyndee Moore and Melanie Marks
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Goods
and
Services
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M&M Publishing Company