The Royal Swedish Academy of Sciences said his work had "deepened our understanding of the relation between short-run and long-run effects of economic policy."
The 73-year-old Columbia University professor showed how low inflation today leads to expectations of low inflation in the future, thereby influencing future policy decision making by corporate and government leaders.
Phelps also pioneered the analysis of the importance of human capital, or workers themselves, for the diffusion of new technology and growth in the business and corporate world, the academy said in its citation.
Phelps is the sixth American to win a Nobel Prize this year, meaning every prize save for the literature and peace prizes, which have not yet been announced, have gone to Americans.
Previous winners of the prize, given out since 1969, ranged from how the control of information affects markets to welfare economics used to explain the economic mechanisms that underlie famine and poverty.
Last year's winners were Robert J. Aumann, a citizen of Israel and the United States, and American Thomas C. Schelling, for their work in game-theory analysis.
The economics prize, worth $1.4 million, is the only one of the awards not established in the will left by Swedish industrialist Alfred Nobel 111 years ago.
The medicine, physics, chemistry, literature and peace prizes were first awarded in 1901, while the economics prize was set up separately by the Swedish central bank in 1968.
The economics prize is the fourth of six to be announced. The winner of the Nobel Prize in literature is to be announced Thursday, Oct. 12, followed by the Nobel Peace Prize in Oslo, Norway, the following day.
Last week, the Nobel medicine prize went to Andrew Z. Fire and Craig C. Mello for discovering a powerful way to turn off the effect of specific genes. John C. Mather and George F. Smoot won the physics prize Tuesday for work that helped cement the big-bang theory of how the universe was created.
American Roger D. Kornberg won the prize in chemistry for his studies of how cells take information from genes to produce proteins, a process that could provide insight into defeating cancer and advancing stem cell research.
The Nobel prizes are presented Dec. 10, the anniversary of the death of their founder. The peace prize is awarded in Oslo, Norway, and the other Nobel prizes are presented in Stockholm.