The second key to understanding economics is understanding that the source of profits and wealth is best thought of as the measure of value-added innovation. Market pricing is merely a method of differentiating, selecting and amplifying those value-added innovations by the degree to which we think they make our lives better.
Because innovation in a free market continuously creates value, free market economies help grow wealth. This idea helps to obliterate several common socialist misperceptions, first being the canard that there exists such a thing as a "fixed pie" of wealth in a free-market economy. This idea is foolish because wealth is created when human ingenuity creates more value for society out of the same basic fixed inputs - the service performed better, the goods purchased for less, etc. Think about it: Every "man-made" product, technology and advancement in the world - from the telephone to the X-ray machine - is merely an innovative collection of natural resources, developed from the same a universe of little over a hundred natural elements.
The key is recognizing that human ingenuity is the source of this wealth-creating, value-added innovation. This idea demonstrates the fundamental reason Karl Marx was wrong - namely because economic value isn't a function of labor, per se, it's about the value of the eventual production in the eyes of your fellow humans. A computer isn't expensive simply because of the value of its silicon chips or difficulty of assembly in a Chinese factory, but by the fact that it makes our lives easier - thanks to Steve Jobs and his well-paid coterie of genius engineers.
In the global marketplace, these innovations are further shared and improved over time. Think: Before the internet was a business, it was merely an obscure toy of the Pentagon - and now it is a trillion-dollar industry revolutionizing our lives. Talk about value-added.
As this surplus value is translated into profits, the economic "pie" thus increases. But regardless of the eventual use of the profit, the innovation itself has already benefitted society. Whether in giving a consumer more benefit for the same price, or producer more efficiency with the same effort, value-added innovation always accrues to the lasting benefit of society. Voluntary free-market trading is thus never a "zero-sum game" because it creates surplus value - by a mere trade or manipulation of existing resources, both participants add value and end up happier than they were before the trade.
It's helpful to think of the traditional economic concept of "Supply" as the market offerings of potential value-added innovations, and "Demand" as the aggregation of the public's Free Choice deciding if they're really worth it after all. Market price is merely the approximate measure of this value, a sale is merely a consumer and producer agreeing on this value, and profits, then, are the incentives for the business providing the most popular value-added Innovation Supply. The Law of Supply and Demand further explains that when products become scarce (low Supply) they become more valuable as a result, and the price (approximate value) thus rises. Similarly, as more people desire these products (high Demand), the price similarly rises.
GDP - the much-maligned index which also happens to be a favorite of economists - is a useful approximation of wealth, despite its many quantitative faults. GDP is the measure of the market price of each individual's production - in other words, the value added from your personal effort. When a country like America has a high GDP, it simply means that we're producing lots of things of high value to our fellow man, whether in goods or services. As a result, we're all rich.
The sheer diversity of human preferences and human ingenuity makes the potential for market-based innovation nearly limitless, and that's why markets play so large a role in our lives in the modern free-market economy. Market-based innovations are found nearly everywhere, from technological inventions to make our lives easier, more enjoyable and longer, to business ideas to save costs and help employees be more productive. These innovations impact all aspects of our daily life, demonstrated by innovations from medicine and transportation to even green energy and organic foods.
An amusing feature of markets, but not surprising given their non-intuitive and non-logical nature, is how little this innovative advancement is appreciated among the general public who reap the benefits of a wealthy, free-market society. But remember this. At the turn of the century, the air conditioner, airplane and the automobile were considered exclusive pleasures of the super-rich. Now, they're universal advancements that help make our world more livable and connected.
Remember, folks - it's never wise to bite the Invisible Hand that feeds you.
