# Economy: What It Is, Types of Economies, Economic Indicators

> **Definition**
>
> An economy is a system within a region, composed of individuals, businesses, and governments, that produce and sell goods and services.

## What Is an Economy?

An economy is a complex system of consumers, businesses, and governments that produce, consume, and distribute goods and services, combining to fulfill the needs of those living and operating within it.

An economy can encompass a nation, a region, a single industry, or even just one family.

### Key Takeaways

*   The production and consumption of goods and services fulfill the needs of those living and operating within an economy.
*   Market-based economies, sometimes called free market economies, are self-regulated, allowing goods to be produced and distributed in response to demand from consumers.
*   Command-based economies are regulated by a government body that determines the goods that are produced, their quantities, and their prices.
*   In the modern world, few economies are purely market-based or command-based.

![Economy](https://www.investopedia.com/thmb/F0ESJtmxPJpxD9Ub_FCCKJqdlEE=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/economy.asp-ADD-SOURCE-9f40b23c92a743cc9c08fa5d17043fe2.jpg)

*The U.S. is an example of mixed economy, combining elements of capitalism and socialism. — Investopedia / Alex Dos Diaz*

## Understanding Economies

An economy encompasses all of the activities related to the production, consumption, and trade of goods and services in an entity, whether the entity is a nation or a small town.

No two economies are identical. Each is formed according to its own resources, culture, laws, history, and geography. Each evolves according to the choices and actions of the participants.

These decisions are made through some combination of market transactions and collective or hierarchical decision-making.

> **Important**
>
> Capitalism is characterized by a market-based economy. Communism is characterized by a command-based economy.

## Types of Economies

In the modern world, few nations are purely market-based or purely command-based. But most lean toward one or the other of these models.  

### Market-Based Economies

Market-based economies enable people and businesses to freely exchange goods and services based on supply and demand.

The United States is mostly a [market economy](https://www.investopedia.com/terms/m/marketeconomy.asp). Producers determine what is sold and produced, as well as the prices to charge. If they expect to succeed, they will produce what consumers want and charge what consumers are willing to pay.  

Through these decisions, the laws of supply and demand determine prices and total production. If consumer demand for a specific product increases, production tends to increase to satisfy the demand. The increased demand causes prices to rise until consumers balk and cut back on their purchases. Demand for the product will then decline, and prices will decrease with it.

This constant tug of supply and demand creates a tendency for a market economy to naturally balance itself. As the prices in one sector rise with demand, the money and labor needed to fill that demand shift to those places where they're needed.

### Command-Based Economies

[Command-based economies](https://www.investopedia.com/terms/c/command-economy.asp) depend on a central government that controls production levels, pricing, and distribution of goods. A command-based economy attempts to supersede the workings of supply and demand.

In such a system, the government owns industries deemed essential on behalf of the consumers who use them. Competition among companies is discouraged or banned. Prices are controlled.

Communism requires a command-based economy. Contemporary examples include Cuba and North Korea.

### Mixed Economies

Pure market economies rarely exist in the modern world because there's usually some degree of government intervention or central planning. Even the United States could be [considered a mixed economy](https://www.investopedia.com/ask/answers/043015/what-are-some-common-features-mixed-economic-system.asp). It may not mandate production, but it has ways to influence it. For example:

*   In late 2021, President Joe Biden ordered 50 million gallons of oil released from the nation's [Strategic Petroleum Reserve](https://www.investopedia.com/terms/g/global-strategic-petroleum-reserves.asp) with the stated aim of lowering gasoline prices by increasing supply.  
    
*   In 2022 and 2023, the Federal Reserve imposed a series of interest rate increases on the nation's banks. The purpose was to raise interest rates throughout the economy in order to reduce demand for loans and therefore reduce inflation in the costs of goods and services.  
    

In truth, most of the world's developed economies mix market-based and command-based models.

China had a command economy until 1978, when it began a series of reforms that encouraged private enterprise.

## Studying Economies

The study of economies and the factors affecting them is called economics. The discipline of economics can be broken into two major areas of focus: microeconomics and macroeconomics.

### Microeconomics

[Microeconomics](https://www.investopedia.com/terms/m/microeconomics.asp) examines the behavior of individual people and businesses to understand why they make the economic decisions they do and how these decisions impact the larger economic system.

Microeconomics studies how a particular value is attached to a product or service. It examines how individuals coordinate and cooperate with each other in business.

Microeconomics tends to focus on economic tendencies, such as how individual choices and actions impact changes in production.

Clearly, principles of psychology and marketing influence microeconomics.

### Macroeconomics

As the name implies, [macroeconomics](https://www.investopedia.com/terms/m/macroeconomics.asp) studies the big picture.

Macroeconomics includes the study of economy-wide factors such as the effect of rising prices or inflation on the economy. It seeks to track and understand the financial indicators that clarify an economy's success or failure over time, such as gross domestic product (GDP), changes in [unemployment](https://www.investopedia.com/terms/u/unemployment.asp), and consumer spending.

In short, macroeconomics studies how the economy as a whole behaves.

## Economic Indicators

As noted above, macroeconomics is the study of the big picture, and that picture is incomplete without a set of [economic indicators](https://www.investopedia.com/terms/e/economic_indicator.asp). These are some of the most closely watched of those indicators.

### Gross Domestic Product (GDP)

[Gross domestic product (GDP)](https://www.investopedia.com/terms/g/gdp.asp) is the total value of all of the completed goods and services produced by an economy during a period of one year.

The gross domestic product of the United States reached $29.37 trillion in the third quarter of 2024.

### Unemployment

In the U.S., the Bureau of Labor Statistics (BLS) publishes a [monthly unemployment report](https://www.investopedia.com/articles/04/092204.asp) that breaks down how many people are working, the average number of hours they are working, and their average earnings. This is used to produce the unemployment rate.

The report estimates the number of people who are working for pay during a given period. More importantly, the number is tracked over time in order to determine whether unemployment is worsening.

The U.S. unemployment rate at the end of 2024 was 4.1%.

### Inflation (or Deflation)

Inflation in consumer prices is measured and tracked so that problems in the economy can be pinpointed. If the rate of inflation is outpacing the rate of income growth, the economy is in trouble. Inflation can be negative, too; this is called [deflation](https://www.investopedia.com/terms/d/deflation.asp), but it is relatively rare.

BLS publishes a key inflation metric known as the [Consumer Price Index](https://www.investopedia.com/terms/c/consumerpriceindex.asp), which tracks the costs of goods and services from month to month. It breaks down its report into the vital areas of consumer spending, such as food, energy, and rent costs. Those numbers determine the rate of inflation.

In December 2024, the Consumer Price Index had risen 2.9% over the previous 12 months.

### Balance of Trade

An economy's [balance of trade](https://www.investopedia.com/terms/b/bot.asp) is a comparison of the amount of money that is spent on imports of goods and services and the amount of money it earns on goods and services it exports. It is measured primarily by recording all of the products that pass through the customs office of a country.

A nation achieves a positive balance of trade when it exports more than it imports. It has a negative balance of trade when it buys more than it sells.

Neither is necessarily good or bad. A nation may have a negative balance of trade because foreign businesses are heavily investing in its future. A nation with a positive balance of trade may have protectionist policies in place that could hurt it in the long run.

## History of the Concept of Economy

The word "economy" derives from the Greek term for household management ("oikonomia"), and the word is still used in that context.

Economics as an area of study was touched upon by philosophers in ancient Greece, notably Aristotle. However, the modern study of economics began in 18th-century Europe, particularly in Scotland and France.

### Development of Modern Economics

The Scottish philosopher and economist [Adam Smith](https://www.investopedia.com/updates/adam-smith-wealth-of-nations/), who in 1776 wrote a landmark book called "The Wealth of Nations," was thought of in his own time as a moral philosopher. He and his contemporaries traced the evolution of economies from prehistoric bartering systems to money-driven and eventually credit-driven economies. 

During the 19th century, the development of technology and the growth of international trade created stronger ties among countries, a process that accelerated into the [Great Depression](https://www.investopedia.com/terms/g/great_depression.asp) and World War II. After 50 years of the Cold War, the late 20th and early 21st centuries have seen a renewed globalization of economies.

## What Is Economics?

Economics is a branch of the sciences that seeks to understand the way a population functions by studying the way its economy functions. Every group of people develops a survival plan based on shared labor and resources. How they do that, and how well they succeed at it, is the central focus of the study of economics.

## What Is Macroeconomics vs. Microeconomics?

Macroeconomics is the study of the overall performance of an economy. It evaluates the stability and progress of an economy over time by analysis of key indicators. These include GDP, employment, inflation or deflation, and the balance of trade.

Microeconomics is the study of the behavior of the individual consumers and businesses that make up the economy. Their motivations, habits, and behaviors are studied to determine whether an economy is functioning in their best interests.

## What Is Economics in Real Life?

All of us participate in economies. We contribute something to the whole by producing or helping to produce a product or offering a service. In return, we receive money that allows us to buy the goods and services that we can't produce for ourselves.

## The Bottom Line

An economy is a system of production and consumption activities that determine the allocation of limited resources. Every individual within an economy contributes to it in some form. In return, each expects a share of the goods and services provided by other members of the community.  

> **Article Sources**
>
> 1.  The White House. "[President Biden Announced Release from the Strategic Petroleum Reserve as Part of Ongoing Efforts to Lower Prices and Address Lack of Supply Around the World](https://www.whitehouse.gov/briefing-room/statements-releases/2021/11/23/president-biden-announces-release-from-the-strategic-petroleum-reserve-as-part-of-ongoing-efforts-to-lower-prices-and-address-lack-of-supply-around-the-world/)."
>     
> 2.  The Board of Governors of the Federal Reserve System. "[Open Market Operations](https://www.federalreserve.gov/monetarypolicy/openmarket.htm)."
>     
> 3.  World Bank. "[The World Bank in China](https://www.worldbank.org/en/country/china/overview)."
>     
> 4.  U.S. Bureau of Economic Analysis. "[Gross Domestic Product (Third Estimate), Corporate Profits (Revised Estimate), and GDP by Industry, Third Quarter 2024](https://www.bea.gov/sites/default/files/2024-12/gdp3q24-3rd.pdf)," Page 2.
>     
> 5.  U.S. Bureau of Economic Analysis. "[THE EMPLOYMENT S ITUATION — DECEMBER 2024](https://www.bls.gov/news.release/pdf/empsit.pdf)."
>     
> 6.  U.S. Bureau of Labor Statistics. "[Consumer Price Index: 2024 in review](https://www.bls.gov/opub/ted/2025/consumer-price-index-2024-in-review.htm)."