Economic Mechanism: Why Everything Works Exactly This Way

How the economy works is a question that interests not only economists and politicians. This system determines how well we live, what salaries we receive, what we wear, and what services we use. Economics is not just a separate world; it’s what surrounds us every day. Its influence is felt everywhere: from the price of a loaf of bread to the employment level of entire regions. Despite this, many people consider this system complicated and unpredictable. Let’s figure it out together.

Supply and demand — the engine of the entire system

Essentially, the economy operates through the interaction of production, sales, procurement, delivery, and use of goods and services. This is the force that keeps modern society moving. The system involves corporations, government budgets, trade unions, and everything else aimed at solving problems for people and companies.

Here’s a practical example: Company A produces a stock. It purchases raw materials from Company B. Then Company C acquires this stock, transforms it into a finished product, and sells it to you. Demand at each stage affects the entire chain. If you suddenly stop buying these types of goods, demand drops, and the entire chain collapses — production decreases, people lose jobs, investments freeze.

Economics is not just a system; it’s a whole organism where each mechanism is connected to another. Everything constantly interacts, everything influences everything.

The three sectors of the economy: from resources to services

Every participant in the economy is you when you buy a product or a company that creates it. Along with countries and governments, we all contribute to the functioning of the system. All participants can be conditionally divided into three sectors of activity.

Primary sector deals with extracting natural resources. Here, metals and minerals are mined, agriculture develops, forests are cut down. All this provides raw materials that then move to the next sector.

Secondary sector takes this raw material and transforms it into finished or intermediate products. Raw materials go into manufacturing. Some goods go directly to stores, others become components of more complex products that require additional processing.

Tertiary sector provides all other services: logistics, marketing, sales, consulting. Some further divide it into the fourth and fifth sectors for more precise classification of different types of services. But overall, everyone agrees that the three-sector model is fundamental.

The four stages of the economic cycle: from growth to crisis

How does the economy work in the long term? It’s very important to understand that the economy moves in waves — it has cycles, periods of growth and decline. First, there’s growth, then the peak, then a downturn, then a bottom. And everything repeats.

Typically, the cycle is divided into four phases:

Expansion — when everything is just beginning. The market is young, everyone is optimistic. This phase often follows a crisis — like a new hope. People start buying more, prices rise, unemployment falls. Production accelerates, companies invest, consumption grows. Demand and supply lift each other upward.

Peak — when the economy is operating at full capacity. This is the maximum point. All production capacities are fully utilized. Prices stop rising, sales slow down, small firms disappear through mergers and acquisitions. Everything seems calm on the surface, but market participants feel that something might go wrong.

Recession — when bad premonitions start to come true. Company expenses unexpectedly increase, people start buying less. Profits fall, stocks become cheaper, unemployment rises. Money stops circulating, investments dry up. Everything moves downward.

Bottom — the bleakest phase. Despair and pessimism reign, even if positive signals are ahead. Often, the bottom is accompanied by a serious crisis. Companies go bankrupt, stocks fall in price, people lose jobs, interest rates on loans rise. Currency depreciates, investments disappear.

After the bottom, the cycle begins anew — the economy starts to rise again.

The three types of cycles: from seasonal fluctuations to structural shifts

Cycle phases are usually the same, but their duration can vary greatly. There are three types of economic cycles:

1. Seasonal cycles — the shortest, lasting a few months. But even over such a short period, they can significantly impact the economy. For example, demand for Christmas trees in December or air conditioners in summer, influence specific industries, and patterns are fully predictable.

2. Economic fluctuations — typically last years. They arise from imbalances between what people want to buy and what companies are willing to offer. The problem is that this imbalance manifests with a delay — by the time you notice the problem, it’s already too late. These cycles affect the entire economy, and recovery can take years. This period is marked by unpredictability, sharp jumps up and down, and can lead to a severe crisis.

3. Structural shifts — the longest, lasting decades. They occur due to technological and social innovations. This cycle spans several generations and cannot be addressed with short-term measures. Usually, it leads to mass poverty and huge unemployment. But there’s a positive side: after such shifts, a new wave of innovation usually comes, lifting the economy to a new level.

Main factors controlling the economy

Many factors influence how the economy works. Every purchase you make adds fuel to the demand engine. At the national level, government policies can turn the economy upside down.

Government policy — one of the most powerful levers. Through fiscal policy, the government decides what taxes to collect and how to spend the budget. Monetary policy involves tools used by the central bank, which controls how much money and credit circulate in the economy. Governments can stimulate a stagnant economy or cool down overheated demand.

Interest rates — the cost you pay for borrowing money. Rates greatly influence whether people spend money and whether companies invest. In developed countries, loans are common. People borrow to start businesses, buy cars or homes, pay for education or healthcare. Low rates make borrowing cheap — people take more loans, spend more, and the economy grows. High rates make borrowing expensive — people hold back, and growth slows.

International trade — another key factor. Countries trade goods and services with each other. If one country has resources needed by another, both benefit. But there’s also a downside — some industries lose jobs when production moves abroad.

Micro vs. macro: two sides of the same coin

The entire economy can be divided into two levels of analysis.

Microeconomics looks at individual parts of the system. It studies how prices are formed, why people make certain decisions, how specific markets work. It examines supply and demand, how GDP affects unemployment, analyzes individual industries and markets.

Macroeconomics looks at the whole picture. It analyzes the level of consumption in a country, trade balances, exchange rates, overall unemployment and inflation, national GDP. Essentially, macroeconomics deals with the global economy of entire countries and how they influence each other.

Microeconomics is about individual points; macroeconomics is about the full picture.

Decoding the mechanism: why it matters

How the economy works is not just a theory for textbooks. It’s a living, constantly changing system on which everyone’s well-being depends — individuals, companies, and entire nations. Economics determines what we buy, where we work, and how much we earn.

In this material, we’ve revealed how this complex and interconnected system is arranged. But there’s no end to studying economics — there’s always something new to understand. The main thing is to start seeing patterns in what’s happening around you.