The functioning of the economy: simpler than it seems

Have you ever wondered why prices go up, why you lose your job, or how nations prosper? The answer lies in how the economy works. Although many see it as a distant and complicated concept, it actually determines every aspect of your daily life: from what you pay for coffee to the money you earn at your job.

What is the economy really?

Essentially, the economy is the network through which we produce, exchange, distribute, and consume goods. It’s not just money—it’s the engine that keeps society moving. Think of it this way: one company needs raw materials from another, the second transforms them, the third distributes them, and finally you buy them as the end consumer. It’s a chain where each link depends on the other. The supply and demand of any product affect all the others.

We all participate in it. Producers, sellers, buyers, governments—all of us contribute to the functioning of the economy every day.

The three pillars that support everything

The economy is organized into three key sectors:

The primary sector extracts natural resources: mining, agriculture, forestry. These are the raw materials that feed everything else.

The secondary sector transforms them: manufacturing, processing, industrial production. It converts raw materials into usable products.

The tertiary sector provides services: distribution, advertising, logistics, and everything that facilitates getting those products into your hands.

How the economy works in cycles

The economy doesn’t grow in a straight line. It moves in cycles of ups and downs. Understanding these phases is crucial to anticipate changes:

Expansion phase: The market is optimistic, demand grows, stock prices rise, unemployment falls. It’s a time of hope after a crisis.

Boom phase: The economy reaches its maximum potential. Factories operate at full capacity. However, something paradoxical appears: although prices stabilize, the market begins to show signs of exhaustion. Small companies disappear through mergers and acquisitions.

Recession phase: Negative expectations from the boom come true. Costs rise, demand falls, corporate profits plummet. Unemployment increases, incomes decrease, and investment almost disappears.

Depression phase: This is the lowest point. Pessimism dominates even when there are positive signals. Companies go bankrupt, interest rates skyrocket, unemployment hits record highs, and investment values collapse.

Three different speeds of cycles

These cycles don’t all last the same. There are three types:

Seasonal cycles (months): They are the shortest. Demand for certain products varies according to the time of year, affecting specific sectors. Although brief, their impact can be significant.

Economic fluctuations (years): Last several years and result from imbalances between supply and demand. They are unpredictable, with irregular ups and downs. They can trigger serious crises that take years for the economy to recover from.

Structural fluctuations (decades): The longest. They arise from technological and social innovations. They cause profound generational changes: catastrophic unemployment but also unprecedented opportunities for innovation.

What factors truly determine how the economy functions

Hundreds of elements influence it simultaneously, but some carry more weight:

Government policies are decisive. Through fiscal policy (taxes and spending), governments stimulate or slow down growth. Monetary policy (controlled by central banks) regulates the amount of money and credit in circulation.

Interest rates directly affect your wallet. When they are low, borrowing is cheaper, people buy more, and the economy grows. When they rise, everything slows down.

International trade drives growth when countries exchange what they produce best. A country with oil trades with another that produces technology. Both prosper—though this can also destroy local jobs in certain sectors.

Microeconomics versus macroeconomics: two perspectives of the same phenomenon

To understand how the economy works, you need two lenses:

Microeconomics looks at details: how supply and demand affect specific prices, how individual consumers and companies behave in particular markets.

Macroeconomics sees the big picture: national consumption, trade balances, exchange rates, inflation, overall unemployment. It observes how entire governments act and how global economies interact.

Both are necessary. The local affects the global, and the global determines the local.

Conclusion: the complexity lies in the details

The functioning of the economy is not a mystery—it’s a system where every action generates a reaction. Every purchase you make, every political decision, every technological change alters the balance. The economy is complex because it’s alive, constantly evolving, driven by millions of simultaneous decisions.

Understanding this allows you to make better decisions, anticipate trends, and understand why the financial world moves the way it does. And in a world where the economy affects every aspect of your life, this knowledge is invaluable.