A country’s economy refers to the totality of transactions involving production, supply and distribution, while affecting the value of currency. An economy is a region of collective application, exchange, distribution, and consumption of products and services, by various agents. In economic terminology, it is defined as a political domain that focus on the practices, policies, and material manifestations related to the production, utilization, distribution, and consumption of resources. It also includes economic practices associated with financial resources, property rights, corporate law and taxation, the operation of markets, and international trade. In addition, an economy allows for a system of prices for goods or services, and the allocation of scarce resources.
A society’s economy, then, is the totality of national goods and services produced or obtained by members of that society. Economists typically use three distinct approaches to classify economies. These include the level of specialization of local production, measured by overall output; the level of demand and potential production for member of society; and the level of productive infrastructure and capacity. A society’s level of total income and potential income, then, is the difference between actual costs of production and potential profits. The level of economic activity, then, is the volume of production relative to the level of potential output.
Developing nations, in comparison to advanced economies, have highly productive economies but also relatively limited levels of overall spending power and income. As a result, their economies are based on the selling of goods, which depend on the supply and demand of specific items, such as manufactured goods, imported goods, capital goods, consumer goods, and so on. Developed economies, by contrast, have built up more extensive stock of fixed assets, such as fixed capital stock, long term investment securities, and credit instruments. They also have developed sophisticated technology to facilitate production of goods, while they have retained a high degree of competitiveness for goods and services.
A mixed economy, meanwhile, is an economy where the primary income derives not from direct sales of physical assets, but from indirect sales of knowledge, skill, technology, capital, and knowledge-based goods and services. The means of production can vary from economy to economy. The level of taxes required, both corporate and personal, can vary significantly from economy to economy. And yet, because knowledge and technology are both important drivers of international trade, most developing economies have maintained a strong market economy.
Developed nations typically have a very high level of taxation and regulation and a low level of investment, both of which inhibit economic growth. These inhibitions, coupled with the high level of corruption that occurs in many developing countries, prevent the efficient allocation of resources and discourage investment. The result is that GDP growth rate tends to be depressed, with a poor mix of consumption, investment, and exports. The net effect is lower gross domestic product growth and higher inflation than in a more liberalized economy. Mixed economies are characterized by high levels of taxation and low levels of subsidies and corporate welfare, tending toward increased economic volatility and slower productivity growth.
A market economy, by contrast, is characterized by plenty of globalization but flexible competition. It is characterized by the fact that many producers rely on a wide range of global supplies for their goods and that they can adjust their prices to cope with changes in the global supply of key inputs, such as labor and capital. Market economies also allow for a flexible exchange rate, allowing goods to be traded internationally even when markets are depressed. Some modern nations, like Japan, have sought to build a manufacturing base that is heavily based in foreign markets. This approach has helped the Japanese economy to grow much more successfully than many other nations in the same situation.
Many modern economies suffer from serious imbalances between supply and demand. In a tight labor market, employers look for workers to replace those that are laid off in business closures and mass lay-offs. In an increasingly costly housing market, consumers search for lower prices on good items like houses and cars and entrepreneurs try to take advantage of this by offering sub-prime or “bad” loans to consumers who cannot qualify for prime rates on these very desirable goods. When this occurs, shortages and overprices develop, pushing down the economy. In these cases, the central economy is forced to cut spending, reduce hours of employment, or both in order to restore higher spending or prevent further deterioration.
One of the major sources of economic volatility is the difference between a market economy and a mixed economy. The existence and growth potential of certain goods and the relative scarcity of others drive the nature of investment, spending, and innovation in the economy. In a market economy, competition, technological change, entrepreneurial initiative, and market-based solutions to a given problem to push the economy forward, producing far greater overall economic stability than in mixed economies where such factors tend to vary unevenly and unpredictably.