When Alex and Shruti trade, both of them are made better off. (Alex does regret buying a certain polka-dot sweater so take this as a general principle, not a mathematical certainty.) The principle is simple but important because exchange makes Alex and Shruti better off whether Alex and Shruti live in the same country and share the same language and religion or they live worlds apart geographically and culturally. The benefits of trade, however, go beyond those of exchange. The real power of trade is the power to increase production through specialization.

Few of us could survive if we had to produce our own food, clothing, and shelter (let alone our own cell phones and jet aircraft). Self-sufficiency is death. We survive and prosper only because specialization increases productivity. With specialization, the auto mechanic learns more about cars and the thoracic surgeon learns more about hearts than either could if each one of them needed to repair both cars and hearts. Through the division of knowledge, the sum total of knowledge increases and in this way so does productivity.

Trade also allows us to take advantage of economies of scale, the reduction in costs created when goods are mass-produced. No farmer could ever afford a combine harvester if he was growing wheat only for himself, but when a farmer grows wheat for thousands, a combine harvester reduces the cost of bread for all.

6

A surprising feature of trade is that everyone can benefit from trade, even those who are not especially productive. The reason is that especially productive people can’t do everything! Martha Stewart may be able to iron a blouse better than anyone else in the world, but she still hires people to do her ironing because for her an hour of ironing comes at the price of an hour spent running her business. Given the choice of spending an hour ironing or running her business, Martha Stewart is better off running her business. In other words, Martha Stewart’s opportunity cost of ironing is very high.

The theory of comparative advantage says that when people or nations specialize in goods in which they have a low opportunity cost, they can trade to mutual advantage. Thus, Martha Stewart can benefit by buying ironing services even from people who are not as good at ironing as she is. Notice that the better Martha Stewart gets at running her business, the greater her cost of ironing. So when Martha becomes more productive, this increases her demand to trade. In a similar way, the greater the productivity of American business in producing jet aircraft or designing high-technology devices, the greater will be our demand to trade for textiles or steel.