My Mom taught me to knit when I was this age and it was one of the best gifts she has given me. Go with short needles, something a bit larger as a child this age wouldn't have the dexterity for anything too small. Love the idea of letting them pick out their own yarn. I'd start with a very small project so that they can easily complete the project...I did a potholder...still have it...dropped stiches and all.
