The functioning of the economy: What really drives the world

Economy is much more than numbers and charts in an analysis document. It is the invisible force that determines whether you can pay rent, land that job you’re seeking, or why a pizza costs more this month than last month. Although many see it as a distant and complex concept, the reality is that we participate in it every time we spend money, produce something, or invest in our future.

What is economy really?

Essentially, the economy functions like a giant gear where we are all interdependent pieces. It is not just the exchange of money for products, but a whole network of relationships that includes the creation, sale, distribution, and consumption of goods and services.

Imagine a simple value chain: a miner extracts copper, a factory transforms it into cables, a construction company buys those cables for buildings, and finally you live in that building. Each link affects the next. If the miner produces less copper, the factory slows down, the builder delays, and you wait longer. Everything is connected this way.

We all participate in this in some way: workers selling their time, companies generating products, governments setting the rules of the game, and even investors betting money expecting profits. No matter your role, you contribute to the functioning of the economy.

The three pillars that support everything

The economy is organized into three main sectors, and each plays a crucial role:

The primary sector is where it all begins. Here natural resources are extracted: metals, minerals, wood, agricultural crops. These are the raw materials that will feed everything else.

The secondary sector transforms these raw materials into useful products. Factories convert iron into steel, cotton into clothing, oil into fuel. This is where the magic of manufacturing and processing happens.

The tertiary sector handles services and distribution. Here we find transporters moving products, advertisers promoting them, as well as doctors, lawyers, and teachers. This sector has grown enormously in modern economies.

Some economists talk about a fourth and fifth sector for more specialized services, but these three models cover most economic activities.

Economic cycles: The repeating pattern

One of the most fascinating patterns of how the economy works is that it never remains stable. Economies rise and fall in predictable cycles, and understanding these phases helps you anticipate changes.

The four phases of the economic cycle

Expansion phase: After a crisis, the market is reborn. Demand grows, companies open new branches, jobs are created, stock prices rise. Optimism permeates the market and everyone spends more money because they feel confident about the future.

Boom phase: This is when the economy is at its peak. Factories operate at 100% capacity, there is no room to grow further. Something interesting happens here: although it looks prosperous on the surface, investors start to suspect it can’t last. Small companies disappear absorbed by larger ones through mergers and acquisitions.

Recession phase: Suspicions turn into reality. Production costs rise, demand falls, corporate profits plummet. Unemployment increases, people cut back on spending, credit contracts. It is a time of uncertainty where everything slows down.

Depression phase: The darkest phase. Pessimism takes over the market even when there are positive signals. Companies go bankrupt, unemployment skyrockets, interest rates rise making loans very expensive, and money loses value. This phase is often associated with severe economic crises.

Then the cycle begins again, creating a pattern that repeats over the years.

Three speeds of economic change

Not all economic cycles last the same amount of time. In fact, there are three types operating on different temporal scales:

Seasonal cycles (duration: months): These are the shortest. For example, the tourism industry thrives in summer but collapses in winter. Clothing stores sell more coats when it gets cold. These changes are predictable and affect specific sectors.

Economic fluctuations (duration: years): These cycles are broader and less predictable. They result from mismatches between what is produced and what is demanded. The tricky part is that these problems are not noticed until it’s too late to avoid them. An economy can take years to recover from a severe fluctuation. They are the ones that generate recessions or financial crises.

Structural fluctuations (duration: decades): These are the deepest transformations, usually caused by major technological or social innovations. The Industrial Revolution was one, the digital era is another. These changes completely redefine how society and work function, causing massive unemployment in some sectors while creating entirely new ones.

Who really pulls the strings?

The functioning of the economy depends on multiple factors, some local and others global:

Government policies are probably the most powerful drivers. Governments can:

• Use fiscal policy: decide how much tax to collect and how to spend the money
• Apply monetary policy: control how much money circulates in the system through central banks

With these tools, they can stimulate an economy in crisis or slow down an overheated one.

Interest rates determine how expensive it is to borrow money. With low rates, more people take out loans to start businesses, buy homes or cars, boosting spending. With high rates, people prefer to save, reducing consumption and growth. It is a powerful mechanism that directly affects your wallet.

International trade connects economies of different countries. When two nations exchange products and services that each produces better, both benefit. But it can also create conflicts, such as unemployment in local industries that cannot compete with cheaper imports.

Consumer confidence also plays a huge role. If you believe there will be a recession, you spend less, which causes recession. If you trust the future, you spend more, stimulating the economy. It’s almost prophetic.

Microeconomics vs. Macroeconomics: Two different lenses

Economy can be analyzed from two complementary perspectives:

Microeconomics focuses on the small: how individual consumers make decisions, how a specific store sets prices, how one company competes against another. It analyzes specific markets, determines why bread prices go up or why egg prices fall. It is the world of small decisions affecting specific groups.

Macroeconomics sees the big picture: how the entire economy of a country performs, national unemployment rates, overall inflation, international trade balance, exchange rates between currencies. It concerns entire governments and how economies of different nations interact.

Both perspectives are necessary. Understanding why prices rise in your local market (micro) is different from understanding why there is inflation in your country (macro), but both are connected.

The challenge of understanding all this

The complexity of how the economy works is almost impossible to fully capture. It is a living system that is constantly evolving, reacting to new technologies, political changes, unexpected global events.

What we can do is recognize the main patterns: the cycles that repeat, the factors that move it, and how our individual decisions add up to create collective changes. With that knowledge, you can make better decisions about where to work, how to invest, when to buy or sell, and how to prepare for the inevitable changes.

Economy is not a mystery; it is simply the reflection of millions of people making decisions every day.

Answers to common questions

What exactly is economy?
It is the system through which society produces, distributes, and consumes goods and services. It involves individuals, companies, and governments in a constant cycle of exchange and transformation.

How exactly does the engine of the economy work?
Everything pivots on supply and demand. People want things (demand), others produce them (offer), and in that meeting, prices are set and jobs are created. Then, factors like government policies, interest rates, and international trade alter this basic balance.

What is the fundamental difference between microeconomics and macroeconomics?
Microeconomics looks at individual decisions and specific markets; macroeconomics looks at the entire system. One analyzes why a store lowers prices; the other analyzes why prices rise across the country.