Updated on April 30, 2024
Article byPrakhar Gajendrakar
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

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 systemEconomic SystemThere are four prominent types of economic systems in the world based on their characteristics. It includes traditional economy, command economy, market economy and mixed economy. read more, 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 growthEconomic GrowthEconomic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read more, and decline. However, it can equally describe the economic structure of a city, state, local market, business center, etc.

Economy Meaning

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Key Takeaways

  • 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, commerceCommerceCommerce is the accumulation of several transactions for a given industry. A transaction is a one-time event where an entity exchanges anything of value with a different entity.read more, 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.

Functions of An Economy

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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.

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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:

Economic Metrics

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#1 – GDP (Gross Domestic Product)

It is an economic indicatorEconomic IndicatorSome economic indicators are GDP, Exchange Rate Stability, Risk Premiums, Crude Oil Prices etc. read more 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 capitalGDP Per CapitalGDP per capita is a parameter that breaks down the GDP of a country to measure the economic prosperity of the citizens by simply dividing the GDP by the total population of that country.read more 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 currencyDepreciation Of A CurrencyCurrency depreciation is the fall in a country’s currency exchange value compared to other currencies in a floating rate system based on trade imports and exports. For example, an increase in demand for foreign products results in more imports, resulting in foreign currency investing, resulting in domestic currency depreciation.read more.

#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:

Types of Economy

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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 economyTraditional EconomyA traditional economy is a system where goods production and distribution are driven by time-honored beliefs, customs, culture, and traditions. read more 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 productionFactors Of ProductionFactors of production define resources used to produce or create finished goods and services, the sale and purchase of which keeps the market economy afloat.read more. 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 economyMarket EconomyA market economy (ME) refers to a form of economic system where businesses and consumers drive the economy with minimal government intervention. In other words, the laws of demand and supply determine the price and quantity of goods produced in an economy.read more 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 SystemMixed Economic SystemA mixed economic system is one that combines capitalist and socialist ideals. It allows for the protection of private assets while also allowing for liberty in use of capital and federal intervention in economic decisions.read more 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)

What is economy and its importance?

An economy consists of producers, buyers, markets, and government agencies actively engaged in the production, distribution, exchange, and consumption of commodities and services in a society. These actions help determine the availability and distribution of production variables to meet people’s needs. It also gives decision-makers (governments and markets) the power to define the value of goods and services in a community. It means that either the state decides the type, quantity, and purpose of the output or markets determine production and price based on supply and demand.

What are the metrics for an economy?

Various metrics, such as GDP (gross domestic product), GDP Per Capita, Income Per Capita, Inflation, and Recession, illustrate economic development and decline. Besides, several factors like population, income, need, consumption, market stability, unemployment, etc., affect an economy.

What are the 4 economies?

The four common types of the economic system are traditional, command-based, market-based, and mixed.

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 –

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