English for business studies

Management
1. What is management?

The success or failure of a company often depends on the quality of their managers.
What do they do?
Peter Drucker, an American business professor, is called the father of the modern management; he suggested that the
work of a manager can be divided into five tasks: planning (setting objectives), organizing and integrating (motivating
and communicating), measuring performance and developing people.
1. Senior managers and directors set objectives and decide how their organization can achieve them.
2. Managers organize: they analyze and classify the activities of the organization.
3. Managers practice the social skills of motivation and communication; they also have to communicate the
objectives to the people responsible for attaining them.
4. Managers measure the performance of their staff to see whether the objectives are being achieved.
5. Managers develop people both their subordinates and themselves.

Top managers also have to consider the future and modify or change the organization’s objectives when necessary, that
will allow business to continue. They also have to manage business relation with customers, suppliers, distributors,
bankers and investors; as well as deal with any crisis.

There are management skills that have to be learnt, but management is also a human-skill and not everyone got it; in
fact excellent managers are quite rare.

Work and motivation

1. Theory X and theory Y

In the human side of enterprise, Douglas McGregor outlined two opposing theories of work and motivation.

Theory X: is the rather pessimistic approach to workers and working which assumes that people are lazy and will avoid
work and responsibility if they can; workers have to be closely supervised and controlled, and told what to do. They
have to be threatened with losing their job and rewarded with incentives. Theory X assumes that most people are
incapable of taking responsibility for themselves and have to be looked after; it has been applied by managers of factory
workers in large-scale manufacturing.

Theory Y: on the contrary, assumes that most people have a

psychological need to work and given the right conditions they
will be creative, ambitious and self-motivated.
This theory is probably more applicable to ‘knowledge workers’.

McGregor’s two theories are based on Maslow’s hierarchy of

needs. Theory X relates to the basic needs at the bottom of the
hierarchy, while theory Y relates to the top needs such as esteem.
McGregor is widely considered to have laid the foundations for
the modern people-centred view of management.

It is impossible to simply replace the authoritarian theory X with

the progressive theory Y.
2. Satisfiers and motivators

Things like good labour relations, good working conditions, good wages and benefit, are incentives that motivate
workers.
In the Motivation to work, Frederick Herzberg argued that such conditions don’t in fact motivate workers.
They are ‘satisfiers’ or more importantly ‘dissatisfiers’ where they don’t exist. Workers who have them take them for
granted. A reward once given becomes a right.
Motivators on the contrary include things such as having a challenging and interesting job, responsibility and
promotion. Unless people are motivated and want to do a good job, they will not perform well.
There are, and always will be, plenty of boring, repetitive and mechanical jobs; and lots of unskilled workers have to do
them.

How can managers motivate people in such jobs?

1. Give them some responsibilities not as individuals but as a part of a team.
2. Job rotation: as doing four different repetitive jobs a day is better than doing only one.
3. People have to identify themselves with the company’s value or corporate culture.

Company structure
1. Wikinomics and the future of companies

In the future companies will use the internet and the ‘wikinomics’ principle (from wiki, the Hawaiian word for quick
and economics). This means collaborating with people outside the traditional corporate structure, letting people around
the world cooperate to improve an operation or solve a problem, and paying them for their ideas.

This is an extension of the trend of outsourcing: transferring some of the company’s internal functions to outside
suppliers, rather than performing them in-house.

Companies will no longer need to get all their knowledge from their own employees.

Red lake, a Canadian gold mine, wasn’t finding enough gold and was in danger of closing down. Its chief executive
heard a talk about Linus, the inventor of Linux; he decided to put the company’s secret geological data on the internet
and offered prize money to experts outside the company who could suggest where undiscovered gold might lie.

2. Company structure

Chain of command: traditionally organizations have had a pyramidal structure, with one person or a group of people at
the top, and an increasing number of people below them at each successive level. There is a clear chain of command
running down the pyramid; all the people know what decisions they are able to make, who their line manager is and
who their immediate or subordinates are.

Functional structure: the activities of most organizations are too complicated to be organized in a single hierarchy. Most
large companies have a functional structure, including specialized production, finance, marketing, sales and human
resources departments. This means that the production and marketing departments cannot take financial decisions
without consulting the finance department. However people are often more concerned with the success of their own
department than that of the company, and because of this there are permanent conflicts between, finance and marketing;
or marketing and production.

Flattening hierarchy and delegating responsibility: a problem with very hierarchical organizations is that people at lower
levels can’t take important decisions; the modern tendency is to reduce the chain of command and make the
organization much flatter. Advanced information technology systems have reduced the need for administrative staff and
enabled companies to remove layers of workers from the structure. Companies eliminated jobs in recession. Owners of
small firms want to keep as much control as possible while managers in larger businesses want to motivate their staff
often delegating decision making and responsibilities to other people.

Matrix management: another way to get round hierarchies is to use matrix management; in which people report to more
than one superior: a product manager with an idea could deal directly with the managers responsible for marketing as
well as managers in finance, sales and production. Otherwise it is necessary to give one department priority in decision
making.
Teams: a further possibility is to have wholly autonomous, temporary groups or teams that are responsible for an entire
project, and are split up as soon as it is successfully completed. But teams are not always very good at decision making
and require a strong leader.

Managing across cultures

1. Managing across cultures

Managing a global multinational company would be much simpler if it require only one set of corporate objectives,
products and services; but local differences often make this impossible. The conflict between globalization and
localization has led to the word ‘glocalization’. Companies that want to be successful in foreign markets have to be
aware of the local cultural characteristics that affect
the way business is done

Richard Lewis has classified different cultures

according to three poles representing different types
of behavior:

1. Linear active cultures are generally

organized and rational, try to act logically
rather than emotionally, plan in advance
and do one thing at a time; they believe in
respecting rules and are what the Dutch
theorist Fons Trompenaars calls
‘universalists’; they are individualist.
2. Multi active cultures in southern Europe,
latin America and Africa attach more
importance to feelings, emotions, intuition,
relationships and connections. People like
to do many things at the same time, are
flexible, good at changing plans and happy
to improvise. They believe in social
hierarchy and are what Trompenaars calls
‘particularist’; they are collettivist.
3. Reactive cultures in Asia prefer to listen to and establish the other’s position, and then react to it. They try to
avoid confrontation, and don’t want to lose face. They rarely interrupt speakers and often avoid eye contact.

Recruitment
1. Filling a vacancy .decide not to replace the person
but to modify other jobs

.try to discover why the .examine the job description for the post,
person has resigned to see whether it needs to be changed

YES .follow up the references of .decide to .either hire an NO

candidates who seem interesting replace person employment agency

.offer the job to the internal candidate .receive applicants, curricula vitae
and think about replacing this person and make preliminary selection

.invite the shortlisted

candidates for an interview

.make a final .write to all the other candidate to inform

selection them that they have been unsuccessful
2. Curriculum Vitae

Name
Address
Phone number
Email address
Date of birth write the month (01 January 2017)
Nationality
Marital status single or married
Objective: what you want to do next is more important than what you have done (a job in international marketing;
production assistant; account manager; financial analyst)
Work experience: starting with the most recent and following (September 2009 – June 2010: repair and maintenance of
department, faculty, staff and student computers)
Education or qualifications: starting with the most recent and following (2016 high school certificate; 2011 secondary
school certificate)
Computer skills
Languages (fluent in Spanish and English, some knowledge in French and German; Italian “mother tongue”)
Hobbies and interests
References

Women in business
1. You’re fired

In Norway, people are enforcing a law that 40% of

directors must be female.
The government had published a list of 12 companies
accused of breaking the law by failing to appoint women
to 40% of their non-executive board directorships.
The main problem is that a law says “a non-executive
director has to be experienced”, but experience is
difficult to find in women. People have had to sack
board members they’ve worked with and trusted for a
lot of years, and to replace them with someone
unknown.
Today Norway set a new global record: it now has the
highest proportion of female non-executive directors in
the world (40%), achieved by the introduction of a
compulsory quota (a woman comes in and a man goes
out), that’s how the quota works.
When you start using the half of the talent you have
previously ignored, then everybody gains; but people
will still go to those they have trusted for years, whom
they had to remove from the board.
It begins a formal and informal system, and that cannot be good for accountability.
The different sectors of economy

1. Another cup of tea

Extract from David Lodge’s novel “Nice Work”.

The university English lecturer, Robyn Penrose, is accompanying Vic

Wilcox, the managing director of a manufacturing company, on a
business trip to Germany; she looked out of the airplane window and
begins thinking about the simple English act of making a cup of tea:
England slid slowly by beneath them; cities, towns and the streets
scattered over a mosaic of tiny fields, connected by thin wires of railways
and motorways. Hard to imagine all the noise on down there. All the
people were inhabiting their own little worlds.
The housewife switching on her electric kettle to make another cup of tea,
gave no thought to the immense complex of operations that made that
simple action possible: building and maintenance of power station that
produced the electricity; the mining of coal or pumping of oil to fuel the
generators; all the steel and aluminium components; the cutting and
pressing and welding of the metal into the kettle’s shell; the assembling
of all these parts with a lot of other components; then the packaging,
advertising, marketing to wholesalers and retailers, calculation of the
price and the distribution.
All this behind the simple act of making a cup of tea.

NB. The economy has a quaternary sector, consisting of information services such as computing, ICT (information and
communication technologies), consultancy (offering advice to businesses) and R&D (research and development,
particularly in scientific fields); news media, libraries, universities and colleges, and other intellectual activities
including culture generally.

Production
1. The Dell theory of conflict prevention

In “The World Is Flat”, the American author Thomas Friedman argues

that outsourcing and global supply chains have very positive international
consequences.
The Dell theory stipulates: no two countries that are both part of a major
global supply chain will ever fight a war against each other as long as
they are both part of the same supply chain; because people don’t want to
fight wars any more. They want to make just in time deliveries of goods
and services.
Michael Dell says: “people are pretty careful to protect the equity they
have built up or tell us why we should not worry; as time and progress go
on there, the chance for a really disruptive event goes down
exponentially”.
Countries whose workers and industries are woven into a major supply
chain know that they cannot fight a war, because they rick the loss of
their place in that supply chain for a long time.
For a country with no natural resources, being part of a global supply
chain is like striking oil that never runs out.

If a supply chain member in Asia decides to start fighting with its

neighbor and disrupts the supply chain, then he will pay for it dearly.
Products
1. Products and brands

A product is anything that can be offered to a market that might satisfy needs and wants; most manufacturers divide
their products into product lines (sold to the same customer groups) and marketed through the same outlets.
Customers’ needs and markets are constantly evolving and companies are always looking to the future, re-evaluating
their product mix.
Most products sold by retailers are branded: a brand is a name, or a symbol, or a logo that distinguishes products and
services from competing offerings, and makes consumers remember the company, product or service.
It can be reinforced by distinctive design and packaging; the key is to create a relationship of trust. Customers have an
image of the brand in their minds, combining knowledge and expectation; some brands successfully represent
customers attitudes or feelings (Nike). Brand is used for B2B marketing of materials and components, as well as B2C
marketing.
Some companies include their name in all their products (Philips), this is called “ corporate branding”; other companies
do “individual branding” and give each product its own brand name, so the company name is less well-known than its
brands (Procter & Gamble produces Pampers, Pringles, Duracell and Gillette).
Some companies have a multi-brand strategy which allows them to fill up space on supermarket shelves, leaving less
room for competitors.
Even if on brand takes business away from another one produced by the same company, the sales don’t go to a
competitor.
Having three out of 12 brands in a market gives a greater market share.
The brand consultancy Interbrand publishes an annual list of the Best Global Brands, which shows that the worth of a
brand can be much greater than a company’s physical asset; the brand value largely comes from the customers’ loyalty:
the existence of customers who will continue to buy the products.

Marketing
1. Vocabulary

Distribution channel: all the companies and individuals involved in moving goods or services from producers to
consumers.
Wholesalers: an intermediary that stocks manufacturers’ goods or merchandise, and sells it to retailers and
professional buyers.
Market segmentation: dividing a market into distinct groups of buyers who have different requirements or buying
habits.
Product differentiation: making a product different from similar products offered by other sellers, by product
differences, advertising, packaging ecc.
Market opportunities: possibilities of filling unsatisfied needs in sectors in which a company can profitably produce
goods or services.
Market penetration: setting a high price for a new product, to make maximum revenue before competing products
appear on the market.
Sales representative: someone who contacts existing and potential customers, and tries to persuade them to buy
goods or services.
Product features: the attributes or characteristics of a product, such as size, weight, color, shape, quality,
quantity, price, reliability, ecc.
Price elasticity: the extent to which supply or demand of a product responds to changes of price.
Market skimming: the strategy of setting a low price to try to sell a large volume and increase market share.
2. The product life cycle

Introduction: the sales volume is low and

customers have to be persuaded to try the product,
costs are high, the company can choose between
high skim pricing to recover development costs or
low penetration pricing to build market share
rapidly, if there are already competitors and
promotion is aimed at educating potential
customers about the product, and building product
awareness.
Growth: public awareness about the product
increases and sales volume rises significant, costs
are reduced due to economies of scale, so
profitability increases, the price can remain the
same because demand is increasing but competitors
aren’t usually yet well established and promotion is
aimed at a much broader audience.
Maturity: sales volume peaks, , the product’s features may have to be changed so that it differs from competing brands,
which involves new costs, prices may have to be reduced because competitors are established in the market but
companies try to defend their market share while also maximizing profit and promotion emphasize product
differentiation.
Decline: sales volume goes down, costs are too high compared to sales and product must be discontinued, the price is
greatly reduced and there is no virtually promotion.

3. Marketing is everything

Decades ago, there were sales-driven companies: these organizations focused on changing customers’ minds to fit the
product, practicing the “any colors as long as it’s black” school of marketing.
As technology developed and competition increased, some companies shifted their approach and became customer-
driven: these companies expressed a new willingness to change their product to fit customers’ request, practicing the
“tell us what color you want” school of marketing.
Successful companies are becoming market-driven, adapting their products to fit their customers’ strategies and
practicing the “let’s figure out together how and whether color matters to your larger goal” marketing, which is oriented
toward creating rather than controlling.
The old approach was slow and unresponsive: as the demands on the company have shifted from controlling to
competing on products to serving customers, the center of gravity in the company has shifted from finance to
engineering, and now to marketing. Marketing today isn’t a function; it is a way of doing business: it has to integrate the
customer into the design of the product.
US companies typically make two kinds of mistake: some get caught up in the excitement and drive of making things,
particularly new creations; others become absorbed in the competition of selling things, particularly to increase their
market share in a given product line. Both approaches are fatal to a business: the problem with the first is that it leads to
an internal focus and companies become fixated on pursuing their R&D that they forget about the customer, the market
and the competition; the problem with the second approach is that it leads to a market share mentality: it turns
marketing into an expensive fight over crumbs rather than a smart effort to own the whole pie.
The real goal of marketing is to own the market; smart marketing means defining the whole pie as yours, and in
marketing what you lead you own, leadership is ownership.
Today marketing is everything.
Advertising
1. Advertising and viral marketing

How companies advertise: Advertising informs consumers about the existence and benefits of products and services;
most companies use advertising agencies to produce their advertising for them: they give the agency a statement of the
objectives of the advertising campaign (as a brief), an overall advertising strategy concerning the message to be
communicated to the target customers. The agency creates advertisements and develops a media plan specifying which
media (newspapers, magazines, internet, radio, television) will be used.

Advertising spending and sales: It is always difficult to know how much to spend on adv: it can increase sales but many
companies just spend a fixed percentage of current sales revenue, or simply spend as much as their competitors. Lots of
creative and expensive advertising campaigns infact don’t lead to increased sales.

Potential drawbacks of advertising: Adv is widely considered to be essential for launching new products: combined
with sales promotion and competitions, adv may generate the initial trial of a new product. But traditional adv is
expensive it doesn’t always reach the target consumers and it isn’t always welcome if it doesn’t reach them. A lot of ads
is located in public spaces but many other ads interrupt people when they’re trying to do something else. (TV
advertising, banner, radio adv).

Word-of-mouth advertising and viral marketing: This is why the best form of advertising has always been word-of-
mouth adv: people telling their friends about good products and services. Today WOM adv has developed into viral
marketing: companies succeed in getting people to spread commercial messages via peer-to-peer networks on the
internet. More and more companies are trying new strategies like setting up blogs or online forums, commenting on
other people’s blogs and social networking websites, making podcasts, and putting videos on YouTube, hoping that
people will use the Share function to send a link to all their contacts: viral marketing allows companies to inform and
persuade at very little cost.

Banking
1. The subprime crisis and the credit crunch

Deregulation in the 1980s was one of the factors that led to

the subprime crisis. When American house prices began to
fall in 2007, many subprime borrowers, defined as those
with poor credit rating and high risk of default, stopped
paying their mortgages as their debt was greater than the
value of their house. The institutions which had issued the
mortgages had created financial products called mortgage-
backed and collateralized debt obligations, which had been
bought by many financial institutions (investment banks,
hedge funds, insurance companies). This process is called
securitization: financial assets like mortgages which
produce a cash flow are grouped together and converted
into securities that are then sold to investors. MBSs and
CDOs give their buyers the right to receive the payments
on the underlying mortgages, and banks bought them
because they believed that house price would continue to
rise, and households would continue to make their
mortgage payments.
When many subprime borrowers stopped paying, the value of subprime rated securities fell dramatically. Many banks
lost billions of dollars on their MBSs; some went bankrupt, and others had to be rescued by governments. These losses
destroyed much of the capital of the world banking system, leading to a credit crisis or a “ credit crunch”: a massive
reduction in the amount of credit available for banks to lend to other banks, businesses and households.
2. Banks and financial institutions

Retail banks or Commercial banks (often called high street banks in Britain) receive deposits from, and make loans to,
individuals and small companies. Investment banks work with big companies, giving financial advice, raising capital by
issuing stocks or shares and bonds, arranging mergers and takeover bids and so on. They also generally offer
stockbroking and portfolio management services to rich corporate and individual clients. Wealthy individuals can also
use private banks, which provide them whit banking, investment services, and hedge funds, which are private
investment funds for wealthy investors that use a wider variety of risk, investing strategies than traditional investment
funds, in order to achieve higher returns. In the USA, where many banks went bankrupt following the Wall Street Crash
in 1929, a law was passed in 1934 (the Glass-Steagall Act) that separated commercial banks and investment banks or
stockbroking firms and prevented commercial banks from doing investment banking business. Starting in the 1980s
many rules were ended by financial deregulation and Glass-Steagall was repealed in 1999. Large banks became
international conglomerates offering a complete range of financial services that were previously provided by banks,
stockbrokers and insurance company. Islamic banks in Islamic countries and major financial centres, offer interest-free
banking. They don’t pay interests to depositors or change interest to borrowers, but invest in companies and share the
profits with their depositors. Some car manufacturers, food retailers and department stores now offer products like
personal loans, credit cards and insurance. Technically these aren’t banks but non-banks financial intermediaries.

Bonds
1. Bonds

Companies finance most of their activities by way of internally generated cash flows. If they need to raise more money
to expand their operations they can issue new shares – selling market – or borrow money (debt finance, usually by
issuing bonds). Companies generally use an investment bank to issue their bonds, and to find buyers, which are often
insurance companies, and pension funds. Bondholders get back their original investment on a fixed maturity date, and
receive interests payments at regular intervals until then. Most bonds have fixed interests rates and are generally safer
than stocks or shares, because if an insolvent or bankrupt company sells its assets, bondholders are among the creditors
who might get some of their money back. On the other hand, shares generally pay a higher return than bonds. The
advantage of debt financing over equity financing is that bonds interest is tax deductible: companies deduct their
interest payments from their profits before paying tax, while dividends paid to shareholders come from already taxed
profits. Debt increases a company’s financial risk: bond interest has to be paid, even in a year without any profits,
whereas companies are not obliged to pay dividends or repay share capital. If tax revenue is insufficient, governments
also issue bonds to raise money, and these are considered to be a risk-free investment. In the US there are Treasury
notes (with a maturity of 2 to 10 years) and Treasury bond (with a maturity of 10 to 30 years), while in GB governments
bonds are known as Gilt-edged stock or Just-gilts. Bonds are saleable instruments that can be traded on the secondary
bond-market. Banks and brokerage companies act as market makers, quoting bid and offer prices for bonds with a very
small spread or difference between them. The price of bonds varies inversely with interests rates. If this rise, existing
bonds lose value; if this falls, existing bonds paying a higher interest rate than the market rate, increase in value.
Consequently the income of a bond depends on its purchase price as well as its coupon.

Stocks and shares

1. Stocks and shares

Successful companies can issue stocks or shares (certificates representing part ownership of the company), to raise
capital to expand their operations. Offering these stocks for sale to financial institutions and the general public changes
the business from a private to a public company, this is called going public. Selling stocks for the first time is called
IPO or initial public offering in the US and a flotation or IPO in Britain. Companies use an investment bank to find
buyers and to underwrite the stock issue, i.e. to guarantee to buy the stocks if there are not enough other buyers. Stocks
and shares are also known as Equity or equities; the most common form is called common stock in the US and ordinary
shares in Britain. After shares have been issued they can be traded on the secondary market at the stock exchange on
which the company is listed or quoted. Some stock exchanges have automatic computerized trading systems that much
up buyers and sellers; others have market makers-traders in stock who quote bid (buying) and offer (selling) prices.
Stock price rise and fall depending on supply and demand, i.e. how many sellers and buyers there are; consequently the
nominal value of the share, is rarely the same as its market price is currently being traded at on the stock exchange.
Companies either distribute part of their profits to shareholders as an annual dividend or keep the profits in the
company, which also causes the value of the stock to rise. Stock markets are measured by stock indexes which show
changes in the average prices of a selected group of important stocks. A period during which most stocks are rising is
called a Bull Market, and on in which most of them fall in value is a Bear Market.
2. Hedge funds

Hedge funds are private investments funds for wealthy investors that trade in securities and derivatives, any try to get
high returns whether markets move up or down. The rise of hedge funds began in earnest 2001, by then stock markets
had been in decline for around 1 year. With no end to the Bear market in sight, investors wanted to make returns that
were not geared to the performance of the stock market; they wished to make an absolute return even if stock markets
fell: they demanded what Cityboys, in their never-ending mission to confuse the general public, like to call Alpha not
Beta. Hence, hedge funds became increasingly popular since they can ‘short’ shares. They can sell shares they don’t
own by borrowing them off a conventional fund so that when the share price falls they make a profit by buying them
back at a cheaper price. As the Bear market continued cash began pouring into these funds. Investment banks had no
choice to prioritize them relative to their old long-only clients because some of these crazy guys really like trading
shares. Whilst your typical pension fund might, on average, hold on to a share for a year or more, certain hedge funds
can be bought in the morning and sold in the afternoon.

Market structure and competition

1. Market structure

In most markets there is a definite market leader: the firm with the
largest USP (unique selling proposition). This is often the first
company to have entered the field, or at least the first to have
succeeded in it. In many markets there is also a distinct
challenger, with the second-largest market share. “Avis used the
slogan ‘We are number two, We are harder’, and got closer to the
leader Hertz”. The second largest company can either attempt to
attack the leader by attacking various market segmentation. Most
of the smaller companies in any industry present no threat to the
leader; many of them concentrate on the followers: selling
profitable niche products that are in some way differentiated from
the products of larger companies. A smaller competitor which
doesn’t differentiate its products is in a dangerous position: if its
products doesn’t have a market share there is no reason for
anyone to buy it.

2. The role of government

The American economist Milton Friedman was well-known for his

view on government: the intervention of the US has been costly in
economic terms; the limitations imposed on our economic freedom
threaten to bring two countries of economic progress to an end.
Intervention has also been costly in political terms: it has greatly
limited our human freedom. An essential part of economic freedom
is freedom to choose how to use our income: how much to spend
on ourselves and on what items; how much to save and in what
form; how much to give away and whom. As consumers we are not
even free to choose how to spend that part of our income that is left
after taxes. Our physician is not free to prescribe many drugs for us
that he may regard as the most effective for our aliments, even the
drugs may be widely available abroad. We are not free to buy an
automobile without seat belts. Another essential part is freedom to
use the resources we possess in accordance with our own values.
Today you are not free to offer your services as a lawyer or a
dentist, or engage in a host of other occupations, without first
getting a permit or license from a government official. You are not
free to work overtime at terms mutually agreeable to you and your employer, unless the terms conform to rules and
regulations laid down by a government official. Freedom cannot be absolute: we do live in an interdependent society;
some restrictions on our freedom are necessary to avoid other, still worse, restrictions. However we have gone far
beyond that point . The urgent need today is to eliminate restrictions, not add to them.
The business cycle
1. What causes the business cycle?

The business cycle or trade cycle is a permanent feature of market economies: balance of payment alternately grows
and contracts. During an upturn, parts of the economy expand to the point where they are working at full capacity, so
that production, employment, business investments, prices and interests rates all tend to rise. A long period of expansion
is called a boom; but at some point there will inevitably be a downturn. The economy will hit a peak and start to
contract again, the demand for goods and services will decline and the economy will begin to work at below its
potential. A downturn that lasts more than six months is called a recession; one that lasts for a year or two is generally
called a depression or a slump: eventually the economy will bottom out, and there will be a recovery or an upturn. The
most probable cause of the business cycle is people’s spending or consumption decisions. A country GDP (gross
domestic product) depends on millions of decisions by consumers and businesses on whether to spend, borrow or save.
When economic times are good, people feel confident about the future and run up debts; at a certain point, spending has
to slow down and debts have to be paid. Similarly, if people are worried about the possibility of losing their jobs in the
near future they tend to start saving money and consuming less, which leads to a fall in demand. Investment is closely
linked to consumption, and only takes places when demand is growing. As soon as demand stops growing, investments
fall, which contributes to the downturn; but if supply exceed demand, prices should fall and encourage people to restart
consumption.
This is the internal theory of the business cycle; there are also external theories, which look for causes outside economic
activity, such as scientific advances, natural disasters, elections or political shocks. The economist Joseph Schumpeter
believed that the business cycle is caused by major technological inventions, which lead to periods of ‘ creative
destruction’ during which radical innovations destroy established companies or industries.

Vocabulary:

Income tax The tax people pay on their wages and salaries
Direct tax A tax on wages and salaries or on company profits
Progressive tax A tax levied at a higher rate on higher incomes
Indirect tax A tax paid on property, sales transactions, imports…
Added-value tax A tax collected at each stage of production, excluding the already-taxed costs
Wealth tax The annual tax imposed on people’s fortunes
Tax evasion Making false declarations to the tax authorities
Tax avoidance Reducing the amount of tax you pay to a legal minimum
Tax heavens Countries where taxes are low and multinational companies set up their head offices

Balance of payment Difference between the funds a country receives and those it pays for all international
transactions
Upturn An increase in economic activity
Downturn A decline in economic activity
Consumption Purchasing and using goods and services
Expectations Beliefs about what will happen in the future
GDP Gross Domestic Product is the total market value of all the goods and services produced in a
country during a certain period
Save To put money aside to spend in the future
Demand The willingness and ability of consumers to purchase goods and services
Supply The willingness and ability of businesses to offer goods and services for sale

Equilibrium A state of balance, for example when supply is the same as demand
Deficit An amount of money that is smaller than is needed
Surplus An amount of money that is larger than is needed (excess)
Fiscal policy Government actions concerning taxation and public expenditure
Monetary policy Government or central bank actions concerning the rate of growth of the money in circulation
Keynesianism The economic theory that government monetary and fiscal policy should stimulate business
activity and increase employment in a recession
2. Keynesianism and monetarism

The lesson of the 1930s: The great depression of 1930s demonstrated that in the short term the market system doesn’t
automatically lead to full employment. John Maynard Keynes argued that market forces could produce a durable
equilibrium with high unemployment, fewer goods being produced, fewer people employed and reduced rates of
income and investment. Classical economic theory stated that in the long run, excess savings would cause interest rates
to fall and investment to increase again, but Keynes replied that ‘in the long run, we are all dead’.
The Keynesian argument: He recommended governmental intervention in the economy to counteract the business cycle:
during an inflationary boom, governments could decrease their spending or increase taxation; while during a recession,
they could increase their expenditure or decrease taxation, or increase the money supply and reduce interest rates, so as
to boast the economy and increase output, investment and employment.
The monetarist argument: In the 1950s and 1960s monetarist economists (Milton Friedman), began to argue that
Keynesian fiscal policy had negative effects in the long term. They insisted that money is neutral, meaning that in the
long run, increasing the money supply will only change the price level and lead to inflation, and have no effect on
output, investment and employment. They argued that government should abandon the attempt to manage the level of
demand in the economy and they should try to make sure that there is constant and non-inflationary growth in the
money supply.
Countercyclical policies don’t work until too late: Monetarists and believers of free markets argue that since
governments aren’t able to foresee a coming recession, their fiscal measures usually only begin to take effect when the
economy is already recovering and simply make the next swing in the business cycle even greater.
Keynesianism return: But when the subprime crisis occurred in 2008 and financial institutions and large automobile
companies began to go bankrupt, Keynesianism suddenly came back. Governments around the world poured huge
amounts of money into the economy but monetarists continued to argue that this would inevitably lead to massive
inflation in the future.
Exchange rates
1. Exchange rates

Gold convertibility: An exchange rate is the price at which one currency can be exchanged for another. After WW II,
the levels of most major currencies were fixed against the US dollar, and the dollar was pegged against gold. One dollar
was 1/35 of an ounce of gold and the Federal Reserve guaranteed that it could exchange this amount of gold for every
dollar in existence. These fixed exchanges rates could only be revalued with the agreement of the International
Monetary Fund (FMI). This system of gold convertibility ended in 1971 because after inflation in the USA, the Federal
Reserve didn’t have enough gold to guarantee its currency.
Market forces: Since that time there has been a system of floating exchange rates. This means that exchange rates are
determined by supply and demand of currencies: if there are more buyers of a currency than sellers, its price will rise; if
there are more sellers, it will fall. Proponents of floating exchange rates, such as Milton Friedman, argued that
currencies would automatically settle at stable rates which would reflect economic realities more precisely than central
bank officials; but they underestimated the extent of speculation, which can push currencies away from levels that
reflect underlying economic conditions.
Parity and speculation: Exchange rates should give purchasing power parity (PPP). The cost of a given selection of
goods and services would be the same in different countries. So if the price level in a country increases because of
inflation, its exchange rate should go down so as to return to PPP. In fact this doesn’t happen because rates are
influenced by currency speculation. Financial institutions, companies and rich individuals all buy currencies, looking
for either higher interest rates or short-term capital gains if a currency appreciates. 95% of the world’s currency
transactions are purely speculative.
Counteracting speculation: Exchange rates changes brought about by speculation clearly cause problems for industry:
it’s possible to some extent to hedge against fluctuations by way of futures contracts, forward planning is difficult when
the price of raw materials bought from abroad can rise or fall rapidly. This was a major reason for the establishment of
the Euro.
Market intervention: Governments and central banks sometimes try to change value of their currency using their foreign
currency reserves to buy their own currency to raise its value, or selling their currency to lower its value; but speculators
have much more money so attempts to ‘manage’ a floating exchange rate have limited success. In 1992 the Bank of
England lost over £3billion in one day trying to protect the value of the pound sterling. Speculators were trading so
much currency that it was impossible for intervention by a central bank to influence rate.