Teaching Expectations Formation Processes Using System Dynamics

Hugh Goldsmith (Senior Lecturer) and Jon Warwick (Principal Lecturer)

School of Computing, Information Systems & Mathematics

South Bank University, 100 Borough Road, London SE1 0AA, UK

Classroom context

Faced with ever larger class sizes and dwindling resources in higher education, there is increasing pressure to move away from traditional lectures, tutorials and seminars, towards new modes of delivery, especially computer-based learning materials. Most of the initiatives to introduce computers into education have focused on the development of hypertext-based courseware (McAlpin, 1992). Despite the interactivity of courseware, there is a tendency for students to become rather passive in front of the technology, and in practice we are still a long way from "replacing" traditional lecturing and tutoring systems (Shackleford, 1990). In part, this is because the learning environment was developed by someone else, and its responses pre-defined. The students have not "constructed" their own learning environment.

For several years, spreadsheets have been used to teach second and final year units on the undergraduate course in Business Mathematics at South Bank University, London. More recently, the System Dynamics (SD) package Stella has been introduced into the undergraduate syllabus. This paper uses the specific example of how SD tools can be used to teach the difficult topic of expectations motivated behaviour in economic modelling to illustrate a more general point about how SD can be used to enhance student learning.

The aims of the Economic Modelling unit include: (1) to provide students with a firm theoretical basis in modern micro- and macroeconomic theory, and in particular the central role played by theories of expectations formation; (2) to refine students' skills in using mathematical methods to formulate and solve economic problems. A specific Learning Outcome is that by the end of the course, students should be able to use computer applications to model and solve a variety of economic problems.

A leap of understanding

Expectations formation plays a central role in modern theories of economic behaviour. Rational, adaptive and extrapolative expectations hypotheses are introduced at an early stage in the undergraduate syllabus (Begg et al, 1994). Expectations motivated behaviour is taken to be the bridge between observed macro-scale phenomena and the aggregated behaviour of representative individual micro-economic agents. But from a student's perspective, there is a considerable leap of understanding required from the static equilibrium models of intersecting supply and demand curves to dynamic behavioural models.

A good example is the macroeconomic consumption function. The Keynesian consumption function model introduced in first year undergraduate courses assumes that consumption is a fixed proportion of income (the marginal propensity to consume) plus "autonomous expenditure". This leads to the simple multiplier model, a linear simultaneous equations model with an explicit solution. In the second year, students are taught the permanent income hypothesis (PIH), in which consumption is a fixed proportion of "permanent income", an unobserved variable which does not respond to temporary fluctuations in income caused by external factors. The model of economic behaviour then hinges on how consumers form expectations of their long run income.

As a teacher, one is faced with trying to explain the implications of different expectations formation processes whilst at the same time making the models realistic enough to be compared with real economic data, which, after all, was the reason for developing the PIH in the first place.

Voyages of discovery

It is not only students who embark on a journey of discovery at the start of a new course. If students face the challenge of learning new material, teachers face the challenge of finding new ways of communicating unfamiliar concepts, stimulating understanding and developing skills. Over the past three years, the authors have been through an odyssey of methods for teaching expectations formation, moving away from the blackboard and into the computer lab. Starting from traditional methods of chalk'n'talk using difference equations and sketch graphs, the first innovation was to get students using spreadsheets. Spreadsheets helped students develop modelling skills and allowed them to investigate the impact of different parameter values on dynamic behaviour, but it was hard to build models with a realistic level of complexity. Students were also presented with a ready-made Microworld, the Keynesian macroeconomic model supplied with Stella. The aim of the exercise was to achieve economic growth and lower unemployment using a mix of monetary and fiscal policies (Sosa et al, 1996). However, feedback from students at the end of the unit revealed that they felt frustrated merely running the model in flight simulator mode. They wanted to learn how to use the package.

Flying in a new world or building your own?

The appropriate teaching method must depend on the intended learning outcomes. There are several initiatives underway to use and evaluate Microworlds as environments for building understanding of complex business and economic systems (Langley & Morecroft, 1996). If learning outcomes are primarily about developing understanding, such as the response of an economy to different policies, then goal centred exploration in a simulation environment is a useful approach. But when the learning outcomes include developing modelling skills, a different approach is needed. SD modelling environments can be used to construct extremely simple models of the expectations formation process and then explore the dynamic implications. Once that understanding has been forged, students are equiped to criticise an existing model and suggest and implement improvements.

Top down … bottom up … or both?

Figure 1. Example of an adaptive expectations model

To build their own models, students firstly need to be taught how to use the package. This is done by giving step-by-step instructions in building simple generic structures for alternative expectations formation processes which are kept as simple as possible to make the dynamics of adjustment processes transparent, an example is shown in Figure 1. The structural differences between models of alternative expectations formation hypotheses are emphasised. Sensitivity analysis is used to contrast structural changes with changes to parameter values.

Students are then given an in-depth assignment based on an existing macroeconomic model to (1) give a critique of the model; (2) propose and implement improvements; and (3) compare their model with real economic data for key variables.

Lessons learned

SD packages are becoming increasingly established as teaching tools on undergraduate and post-graduate University courses. The Microworlds approach is readily accepted by students who have grown up in the age of computer games. The approach enhances students understanding of the link between structure and behaviour for complex dynamic systems and allows them to explore relationships amongst decision variables. But a further stage in understanding is to be able to question existing models and eventually build your own.

In many socio-economic systems, the key to understanding behavioural dynamics is the way in which economic agents update expectations based on new information. The authors experiences suggest that SD tools offer considerable advantages in helping students make the leap of understanding from the comparative statics of simultaneous linear model systems to the dynamics of expectations and feedback. By using the combined bottom-up and top-down approach described in this paper students gain the confidence to first criticise and then attempt to improve on existing models with a realistic level of complexity. Additionally, providing historic data for key variables encourages students to contrast models with reality.


Begg D K H, Dornbusch R and Fischer S, 1994. Economics. McGraw Hill, London, UK.

Langley P and Morecroft J, 1996. Learning from Microworld Environments: a Summary of the Research Issues. Proc 1996 Int. System Dynamics Conference, Cambridge Massachusetts.

McAlpin A, 1992. The computers in teaching initiative. Proc. Conference on Developments in the Teaching of Computer Science, April 1992, University of Kent, pp152-157.

Shackleford R L, 1990. Educational computing: myths versus methods - why computers haven't helped us and what we can do about it in Proc. of Conf. on Computers and the Quality of Life 1990, Washington DC, pp139-146.

Sosa H H A, Castro J D M, Vivas R V J and Mantilla J A P, 1996. Microworlds: A System Dynamics Application in Learning Keynesian Macroeconomics. Proc. of the 1996 International System Dynamics Conference, Cambridge Massachusetts, July 1996, pp28-31.

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