The simple equation Profits = Revenues - Costs represents the unifying field theory of economics. If this strikes you as pathetically simplistic, we're sympathetic (maybe that's why they call economics a soft science). Nevertheless, this simple equation represents a remarkably powerful framework for analyzing all economic activities. After all, ECONOMICS IS ALL ABOUT RESOURCE TRANSFERS, taking resources away from one possible use and redirecting them towards something else. Health care, job training, child care, workplace safety, environmental cleanup--properly understood, these things are nothing more than resource transfers. If we direct more resources to child care, we have less resources for other things. If we want to provide better health care to more people, we cannot help but deprive consumers of other goods and services that would have produced happiness. The key question is--always is--which use of a resource provides the greatest happiness?

To better visualize how profits help us to answer this question, let's return to the BIG PICTURE.

Under the right circumstances--we'll talk more about this later--profits provide a measure of the net gains in happiness from resource transfers, with revenues measuring the gains and costs the losses. If profits are positive, the firm has generated an increase in society's happiness. If profits are negative, the production activities of the firm have served to decrease society's happiness.

IN A FREE-MARKET ECONOMY, PROFIT-MAXIMIZING FIRMS ARE AN UNWITTING ACCOMPLICE IN THE GREAT SOCIETAL TASK OF MAXIMIZING HAPPINESS. This is a powerful insight. Take the greediest, most selfish, money-grubbing, heartless capitalist you can imagine. In his never-ending lust to maximize his own profits, a startling thing occurs. The greedy capitalist becomes indistinguishable from the zealous altruist who works untiringly for the improvement of the masses. It is as if the capitalist woke up each morning and asked himself, "How can I improve the lot of my fellow citizens today?" Ebenezer Scrooge becomes Mother Theresa, or at least her economic equivalent.

In fact, one could say that it is as if an INVISIBLE HAND guided the firm unknowingly to do what was good for society. Invisible hand indeed. Just so you don't labor under the misconception that any of this is particularly new, consider the words of Adam Smith, taken from his book The Wealth of Nations, first published in 1776:

ONE IMPLICATION OF THIS IS THAT WE SHOULD BE SUSPICIOUS OF POLICIES THAT PROPOSE RESOURCE TRANSFERS WHICH PROFIT-MAXIMIZING FIRMS ARE NOT WILLING TO UNDERTAKE. If more child care would really improve society's happiness, we should expect profit-maximizing firms to be able to make good money operating day care centers. If providing more health care really is a good thing, for-profit hospitals will rise up to meet the need. Likewise, if redirecting resources to produce better trained workers would make society better off, then we should see firms opening up "worker education" centers, training workers for a profit. And we should cast a wary glance at politicians who talk about the need for government job-training programs to help America "grow stronger" in the world economy.

Does this mean that every activity that loses money decreases society's happiness? And any activity that makes money increases society's happiness? No, it does not. Recall that at this point in our analysis we are operating in a world without market imperfections. As we shall see, the presence of market imperfections will cause profits to distort the impact of resource transfers on society's happiness. Our point here is merely that one should be "suspicious" of calls for society to undertake resource transfers which profit-maximizing firms are unwilling to undertake. That is, we should ask ourselves: if this activity is so good for society, how come profit-maximizing firms aren't doing it?

Maybe you're skeptical that our "unifying field theory" is complete enough to analyze the complicated issues we promised to discuss in the first chapter. Good. We plan to spend a lot of time addressing these and other issues in greater detail. In the meantime, keep your skepticism.