Economy

Economy Meaning

An economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society. These activities collectively help a nation determine the availability and allocation of scarce resources to fulfill the needs of its people.

Also known as an economic system, it distributes land, resources, labor, and capital to produce for consumption. Furthermore, decision-making authorities define the value of goods and services within a community. The term commonly applies to a country, depicting its resources, consumption, inflation, economic growth, and decline. However, it can equally describe the economic structure of a city, state, local market, business center, etc.

• The economy means a system comprising producers, customers, markets, and government agencies involved in the production, distribution, exchange, and consumption of goods and services in a society.
• These activities aid in determining the availability and distribution of production factors to meet the requirements of people. It also empowers decision-makers (governments and markets) to define the value of commodities and services within a community.
• Various indicators demonstrate real economic growth and decline, such as GDP (gross domestic product), GDP Per Capita, Income Per Capita, Inflation, and Recession.
• Traditional, command, market, mixed, green, and gig economies are examples of an economic system.

How Does The Economy Work?

An economy comprises processes and activities tied to the production, commerce, distribution, and consumption of commodities and services in a region. It involves producers, customers, markets, and governments. Based on the governing power, an economic system can be primarily of two types. The one in which the government determines the type, quantity, and purpose of the output. And then there is the second, where markets determine production and price based on supply and demand.

It can be estimated for any period but is generally done quarterly, with the entire year divided into four quarters: Q1, Q2, Q3, and Q4. Factors contributing to the formation of an economy include history, geography, technological advancements, and social, political, and legal frameworks.

The term has a Greek origin, meaning household administration or management in English. Adam Smith, an economist, detailed how the economy evolved from the ancient bartering system to the modern money-driven and credit-based structure.

Economic Metrics

Various metrics, such as income, need, and lifestyle, have been established to demonstrate real growth and decline in an economy. The following are some of the standard ones used in the context of a country's economic system:

#1 - GDP (Gross Domestic Product)

It is an economic indicator for a nation's growth. It indicates all goods manufactured and services rendered within a country over a specific period. However, it takes into account the economic activity driven by financial transactions. An increase in domestic production year over year reflects an economic boom.

#2 - GDP Per Capita

GDP Per capital represents the economic output per person in a country and can be obtained by dividing its GDP by its overall population.

#3 - Income Per Capita

It calculates a citizen's average annual income in a country to illustrate how affluent or economically stable they are. Also, it is an essential aspect in influencing economic growth.

#4 - Inflation

It is a common phenomenon, representing the sudden increase in the average price of goods and services. These are items that people use regularly. It further depicts the depreciation of a currency.

#5 - Recession

This situation occurs when overall production and industrial activities in a country are at their lowest. As the economic system does not perform well in this phase, the unemployment rate increases severely. It is one of the critical phases an economy must avoid or prevent. Many countries have faced it in history, with the most infamous being the Great Depression of 1929.

All these factors are critical to understand how the economic system functions and what reforms it requires.

Types Of Economy

Countries around the world acknowledge and implement four different types of economies, depending on their circumstances and assumptions:

1 - Traditional Economic System

It is the oldest economic framework based on industries like agriculture and fishing dominant in rural sectors and developing nations. Even though the traditional economy focuses on products and services, there is a minimal labor division due to limited resources.

2 - Command Economic System

Command economy is abundant in resources managed, controlled, and governed by a central authority, i.e., the state. The government devises policies for production, pricing, and distribution of resources while keeping in mind the interest of citizens.

In this planned economic framework, political agents have the decision-making power to control the factors of production. It is widespread in communist economies, such as the Soviet Union and China, and sometimes referred to as a socialist economic system.

3 - Market Economic System

It describes an economic system based on free-market principles, with relatively little government intervention in resource allocation. That is why a market economy is often called a capitalist economy.

Although market forces allow commerce based on supply and demand, the government promotes anti-monopoly and pro-fair trade measures. On the one hand, producers control production factors and pricing, and on the other hand, consumers own their purchases and decide on the pay. Notably, its rare global presence does not hinder its ability to stimulate growth.

4 - Mixed Economic System

Mixed Economic System is the hybrid of the market (free-market) and command-based (socialist) economies and exhibits the coexistence of public and private sectors. Private businesses and the government strictly regulate the mixed economy. Due to its hybrid nature, market imbalances are a regular occurrence in this economic system. Therefore, the state introduces regulations and other social benefits, such as education, to strike a balance.

In addition to these, there are two more popular economic systems – green and gig economy. The former indicates public and private investments directed at building green infrastructure leading to employment and income growth. The latter refers to a model in which companies create temporary jobs online, such as freelancers or independent contractors.

Economy Examples

Let us consider the following examples to gain a better understanding of the concept of the economy:

Example #1

A small marketplace has only three business establishments - a gas station, a clothing store, and a grocery store.

In the first month, everyone in the locality buys monthly groceries from the grocery store. But only one or two families purchases clothes while gas consumption remains constant.

In the second month, grocery sale remains constant, but every family buys clothes from the clothing store due to the festival. Again, the consumption of gas is somewhat equivalent to the previous month.

In the third month, a rumor has it that petrol prices may hike and sudden inflation may lead to an increase in the prices of groceries. So people decide to minimize their monthly grocery expenditure by purchasing fewer items than usual. Also, no one buys clothes, and everyone fills up their vehicles with more gas.

To summarize, the economy of that marketplace will look something like this. In the first month, all three businesses contributed to it on average. However, the clothing business profited more than usual in the second month while the other two remained constant. People bought more petrol and gas in the third month, but inflationary increases in grocery prices resulted in fewer purchases. Therefore, in one quarter, each month played a different role in the economic system represented by the GDP of the marketplace.

Example #2

Now, the above example may seem insignificant of how the economic system works. However, when we talk about a nation, several elements influence it directly or indirectly, such as population, income, market stability, unemployment, etc.

For example, after the COVID-19 pandemic-related lockdowns, the U.S. GDP grew to  6.6% yearly in Q2, 2021, up from 6.3% in Q1, 2021. In contrast, during the COVID-19 pandemic, the Indian economy contracted by a record  7.3% in the fiscal year that ended in March 2021.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to the Economy and its meaning. Here we discuss the types, functions of the economy, and how does it work, along with examples. You may learn more about financing from the following articles –

• Economics
• Economic Equilibrium
• Economic Stimulus Package
• Economic Union