Decoding the secrets of how the economy works

Economy is much more than numbers and charts: it is the engine that drives our daily decisions, from what we buy to where we invest our money. Understanding how the economy works is essential in a world where every transaction, every purchase, and every investment creates waves that affect global markets.

The core of any economic system

The foundation of how the economy functions rests on a simple principle: supply and demand. Producers generate goods, consumers acquire them, and in this exchange, the price is established. However, this seemingly simple circle expands exponentially when we include companies, governments, workers, and consumers—all contributing simultaneously to the system.

Think of it as a value chain where each link is essential. Raw materials are extracted, transformed into components, then into final products, and finally distributed to users. If any link fails, the entire system is affected.

The four stages every market experiences

Although we may not always realize it, the economy moves in predictable cycles. These economic cycles present four clearly identifiable phases:

Expansion: The market awakens with renewed optimism. Demand grows, stock prices rise, unemployment falls, and production soars. This is the phase we all want.

Peak: The economy reaches its maximum potential. Production capacities operate at 100%, but a warning sign appears: while the market remains bullish, expectations start turning negative. Small companies disappear, absorbed by large corporations.

Recession: Negative expectations become reality. Costs rise, demand falls, stock prices decline, and unemployment increases. Spending contracts dramatically.

Depression: The most severe phase of the economic cycle. Pessimism is absolute, stock prices plummet, the unemployment rate soars, and many companies go bankrupt. It is then, deep down, that the seeds of recovery are sown.

Three different rhythms of fluctuation

Not all economic cycles operate at the same pace. There are three distinct types:

Seasonal cycles last months and affect specific sectors. A retail sector experiences its peak at Christmas, then declines. They are predictable.

Economic fluctuations extend over years, resulting from imbalances between supply and demand. These cycles are unpredictable, with irregular ups and downs that can lead to serious crises.

Structural fluctuations are the longest-lasting, spanning decades. Driven by technological innovations and social changes, they generate profound transformations. The digital revolution is a classic example: it destroys jobs in certain sectors while creating entirely new industries.

Who truly makes up the economy

Anyone who spends money participates in the economy. You, as a consumer, are the economy. The company that manufactures the product is the economy. The government that regulates it is the economy. The three sectors organizing economic activity are:

• Primary sector: Extracts natural resources (mining, agriculture, forestry)
• Secondary sector: Transforms raw materials into manufactured products
• Tertiary sector: Provides services (distribution, advertising, logistics)

Each sector depends on the previous one, creating total interdependence.

The forces that drive how the economy works

Beyond the basic cycle, several factors determine economic direction:

Government policies are accelerators or brakes. Fiscal policy (taxes and spending) and monetary policy (control of money and credit) can stimulate or deflate entire economies.

Interest rates directly affect the behavior of consumers and investors. Low rates encourage borrowing and spending; high rates discourage it.

International trade expands opportunities when countries exchange goods that they naturally produce better than others. But it can also destroy local jobs in certain sectors.

Micro versus Macro: two perspectives of the same universe

There are two ways to analyze how the economy functions: from the bottom up or from the top down.

Microeconomics examines the behavior of individual entities, households, and companies. It analyzes how a consumer makes purchasing decisions or how a company sets prices. It focuses on specific markets.

Macroeconomics observes the entire economy: entire countries, international trade, global unemployment rates, national inflation. It is the aerial view of all economic activity.

Both perspectives are complementary. Microeconomics explains why you buy; macroeconomics explains why your purchasing power changes.

Reality: a living and unpredictable system

Understanding how the economy works is not solving a mathematical equation. It is recognizing that the economy is a living organism, constantly evolving, where millions of individual decisions create collective patterns. Some patterns are predictable, others escape all prediction.

The important thing is that every economic decision you make—every purchase, every investment, every saving—contributes to the movement of the global system. The economy is not something distant and abstract. You are part of it, and it is part of you.

Frequently Asked Questions

What exactly is the economy?
A dynamic system where goods and services are produced, distributed, and consumed. It includes every individual, company, and government on the planet.

How does the economic cycle affect my personal decisions?
During expansion, it’s easier to get credit and find employment. During recession, both contract. Understanding where we are in the cycle helps you make smarter decisions.

Should I think in microeconomics or macroeconomics?
Both. Your personal behavior is microeconomics; the context where you live is macroeconomics. You need to understand both to navigate correctly.