Read this before teaching... Circular Flow of Income

Circular Flow is a funny topic. AQA guidance states that it is ‘the starting point of all macroeconomic analysis, and so should be well developed in the classroom’, but exam questions on the matter are often superficial and account for few marks. It’s therefore easy to overlook its importance.


For AQA, marginal propensities aren’t needed at all at AS-Level. Students are, however, required to calculate the value of the multiplier from an initial change in injections and the resulting change in national income. At A-Level, they need to be able to calculate multiplier from the MPC, but not from MPW. In fact, there aren’t any specific references to MPW, nor MPT, MPM or MPS.


Edexcel students are expected to know slightly more here. The relationships between MPC, MPT, MPS, MPM, MPW and the multiplier are required for both AS and A-Level.


As far as I can see, neither board requires knowledge of average propensities.


Danger Points

Students often make mistakes in this area, either through carelessness or misconceptions. Key mistakes you’re likely to see are:

· Confusing imports and exports on the flow diagram. I reckon this is because it’s a little counterintuitive to think of exports as inflows of money.

· Struggling with the MPC abbreviation. We use it for Marginal Propensity to Consume, Monetary Policy Committee and Marginal Private Cost.

· Confusing MPC, APC and value (or volume) of C. As I said before, I don’t believe that APC is generally a requirement but sometimes not mentioning it causes a vacuum that students fill with their own misconceptions.

In addition, we often see students write something like ‘the increase in income causes MPC to increase’, when in fact the opposite is usually true.


In my experience, it’s best to address these errors directly. I find this ‘Always, Sometimes, Never’ task useful in doing this.


Diagram

After a lot of iterations, I’ve settled on a favourite version of the diagram (when introducing it to students, at least).





Firstly, it has no crossed lines to confuse things. More importantly, it’s easy to build the diagram up in front of students, starting with just consumers and producers and removing more assumptions to make the model more realistic with each step. First, we remove the assumption that we spend all that we earn. Then we remove the assumption that the market is completely free. Then we remove the assumption that we only trade within our own borders. I’ve said before that I believe ‘building the diagram’ is essential for students, especially weaker students, to grasp what’s going on. Finally, it doesn't particularly emphasise any injection or withdrawal and it’s slightly more obvious that the relative placement of banks, government and the rest of the world isn’t particularly important.


That said, it’s good to expose students to lots of versions. In the past, I have taken a few versions from a google image search, blanked out various parts and asked students to fill in the gaps. I can’t share this because I don’t own the images but it shouldn't be too dificult recreate yourself if you want to try it.


Simulations

I can’t attest to having used these in the classroom but they seem popular so I thought they were worth including. Econoland is common in the States, although Martha Rush points out that you might want to spend a little bit of time on some prior knowledge first. WJEC have their own version with poker chips, which also extends to the derivation of AS. You can find that extension here.


It’s not a simulation, but I think there are some benefits of treating the diagram as a road map. You can do it on a whiteboard, or pilfer toy cars from colleagues and draw it on the table (or use the back of some wallpaper) to show the movement around the flow. I like to ask students what size of the economy is in this metaphor, or how we can show the size of consumption, or what represents MPC. It might also be useful to make the distinction between APC and MPC and show the difference on this model.


Videos

Aside from the Econplusdal and Tutor2u staples, I like this one from the St Louis Fed which follows a dollar around the economy. There is also this very clear demonstration of the (negative) multiplier, but a warning that it's made by the Labour Party so it's politically loaded. It might also interest students to see this video of a MONIAC, an early economics computer using hydraulic systems to show the circular flow.


Activities

WJEC resources are good for this unit; I recommend activities 1b and 5. Activity 1 is a nice exercise to practice analysing injections and withdrawals. Activity 5 is a quick (if old) article illustrating the multiplier, followed by a few questions.


Another useful article is this one looking at a local economy (thanks to Mrs Keys for posting this way back in 2013!). It’s also a nice little activity to look through recent budget or manifesto coverage and find 3 injections and 3 withdrawals.


This entry from Core Econ's series on How Economists Learn from Facts gives an interesting account of the effect of Mafia laws on the multiplier, and is also a really nice introduction to Natural Experiments.


There is a quantitative element to this topic, and so calculations practice is important. I recommend this worksheet posted by Ali Mclean as a great place to start if you’re on Edexcel. If you’re AQA, or need more practice, for homework or revision or extension, you could take a look at this calculation pack, which has a selection of differentiated worksheets. As well as questions similar to those we often see in exams, it has some harder questions to develop fluency in the relationships between MPC and multiplier, as well as those between MPW, MPS, MPT and MPM for Edexcel. For example, some questions give extra information as a red herring, so students have to be able to identify which pieces are important. It also incorporates skills like adding billions to trillions, something which can throw some students.


I mentioned this 'Always, Sometimes, Never' activity earlier, it’s a nice rich activity which promotes some good discussion and addresses some common misconceptions. On the other end of the spectrum there is also this clear-cut cloze worksheet which is good as a check for understanding. The calculation pack, 'Always,Sometimes, Never' activity and close worksheet are available as a bundle if you're looking to save a few bob.


Debates

With its physicsy-feel, it's easy to teach this topic as scientific fact. Whilst I haven’t ever seen a question asking students to address criticisms of the model, it can be helpful for evaluation and also forms part of the bigger Keynesian-Classical (-Rational Expectations) debate. You might want to address whether the multiplier even exists, and if so how big is it? Is it positive? Does it matter anyway? Is that Savings-Investment relationship accurate? The Economist has several really nice articles here. Some are a little heavy going so you might want to leave them until the end of the course or use them for your own wider reading. I recommend this one, this one and this one.