Among the twelve principles of economics described in Chapter 1 was the principle of gains from trade—the mutual gains that individuals can achieve by specializing in doing different things and trading with one another. Our second illustration of an economic model is a particularly useful model of gains from trade—trade based on comparative advantage.

One of the most important insights in all of economics is that there are gains from trade—that it makes sense to produce the things you’re especially good at producing and to buy from other people the things you aren’t as good at producing. This would be true even if you could produce everything for yourself: even if a brilliant brain surgeon could repair her own dripping faucet, it’s probably a better idea for her to call in a professional plumber.

How can we model the gains from trade? Let’s stay with our aircraft example and once again imagine that the United States is a one-company economy where everyone works for Boeing, producing airplanes. Let’s now assume, however, that the United States has the ability to trade with Brazil—another one-company economy where everyone works for the Brazilian aircraft company Embraer, which is, in the real world, a successful producer of small commuter jets. (If you fly from one major U.S. city to another, your plane is likely to be a Boeing, but if you fly into a small city, the odds are good that your plane will be an Embraer.)

In our example, the only two goods produced are large jets and small jets. Both countries could produce both kinds of jets. But as we’ll see in a moment, they can gain by producing different things and trading with each other. For the purposes of this example, let’s return to the simpler case of straight-line production possibility frontiers. America’s production possibilities are represented by the production possibility frontier in panel (a) of Figure 2-4, which is similar to the production possibility frontier in Figure 2-1. According to this diagram, the United States can produce 40 small jets if it makes no large jets and can manufacture 30 large jets if it produces no small jets. Recall that this means that the slope of the U.S. production possibility frontier is ¾: its opportunity cost of 1 small jet is ¾ of a large jet.

Panel (b) of Figure 2-4 shows Brazil’s production possibilities. Like the United States, Brazil’s production possibility frontier is a straight line, implying a constant opportunity cost of a small jet in terms of large jets. Brazil’s production possibility frontier has a constant slope of -⅓. Brazil can’t produce as much of anything as the United States can: at most it can produce 30 small jets or 10 large jets. But it is relatively better at manufacturing small jets than the United States; whereas the United States sacrifices ¾ of a large jet per small jet produced, for Brazil the opportunity cost of a small jet is only ⅓ of a large jet. Table 2-1 summarizes the two countries’ opportunity costs of small jets and large jets.

Now, the United States and Brazil could each choose to make their own large and small jets, not trading any airplanes and consuming only what each produced within its own country. (A country “consumes” an airplane when it is owned by a domestic resident.) Let’s suppose that the two countries start out this way and make the consumption choices shown in Figure 2-4: in the absence of trade, the United States produces and consumes 16 small jets and 18 large jets per year, while Brazil produces and consumes 6 small jets and 8 large jets per year.

But is this the best the two countries can do? No, it isn’t. Given that the two producers—and therefore the two countries—have different opportunity costs, the United States and Brazil can strike a deal that makes both of them better off.

Table 2-2 shows how such a deal works: the United States specializes in the production of large jets, manufacturing 30 per year, and sells 10 to Brazil. Meanwhile, Brazil specializes in the production of small jets, producing 30 per year, and sells 20 to the United States. The result is shown in Figure 2-5. The United States now consumes more of both small jets and large jets than before: instead of 16 small jets and 18 large jets, it now consumes 20 small jets and 20 large jets. Brazil also consumes more, going from 6 small jets and 8 large jets to 10 small jets and 10 large jets. As Table 2-2 also shows, both the United States and Brazil reap gains from trade, consuming more of both types of plane than they would have without trade.

Both countries are better off when they each specialize in what they are good at and trade. It’s a good idea for the United States to specialize in the production of large jets because its opportunity cost of a large jet is smaller than Brazil’s: < 3. Correspondingly, Brazil should specialize in the production of small jets because its opportunity cost of a small jet is smaller than the United States: ⅓ < ¾.

What we would say in this case is that the United States has a comparative advantage in the production of large jets and Brazil has a comparative advantage in the production of small jets. A country has a comparative advantage in producing something if the opportunity cost of that production is lower for that country than for other countries. The same concept applies to firms and people: a firm or an individual has a comparative advantage in producing something if its, his, or her opportunity cost of production is lower than for others.

One point of clarification before we proceed further. You may have wondered why the United States traded 10 large jets to Brazil in return for 20 small jets. Why not some other deal, like trading 10 large jets for 12 small jets? The answer to that question has two parts. First, there may indeed be other trades that the United States and Brazil might agree to. Second, there are some deals that we can safely rule out—one like 10 large jets for 10 small jets.

To understand why, reexamine Table 2-1 and consider the United States first. Without trading with Brazil, the U.S. opportunity cost of a small jet is ¾ of a large jet. So it’s clear that the United States will not accept any trade that requires it to give up more than ¾ of a large jet for a small jet. Trading 10 jets in return for 12 small jets would require the United States to pay an opportunity cost of = ⅚ of a large jet for a small jet. Because ⅚ > than ¾, this is a deal that the United States would reject. Similarly, Brazil won’t accept a trade that gives it less than ⅓ of a large jet for a small jet.

The point to remember is that the United States and Brazil will be willing to trade only if the “price” of the good each country obtains in the trade is less than its own opportunity cost of producing the good domestically. Moreover, this is a general statement that is true whenever two parties—countries, firms, or individuals—trade voluntarily.

While our story clearly simplifies reality, it teaches us some very important lessons that apply to the real economy, too.

First, the model provides a clear illustration of the gains from trade: through specialization and trade, both countries produce more and consume more than if they were self-sufficient.

Second, the model demonstrates a very important point that is often overlooked in real-world arguments: each country has a comparative advantage in producing something. This applies to firms and people as well: everyone has a comparative advantage in something, and everyone has a comparative disadvantage in something.

Crucially, in our example it doesn’t matter if, as is probably the case in real life, U.S. workers are just as good as or even better than Brazilian workers at producing small jets. Suppose that the United States is actually better than Brazil at all kinds of aircraft production. In that case, we would say that the United States has an absolute advantage in both large-jet and small-jet production: in an hour, an American worker can produce more of either a large jet or a small jet than a Brazilian worker. You might be tempted to think that in that case the United States has nothing to gain from trading with the less productive Brazil.

But we’ve just seen that the United States can indeed benefit from trading with Brazil because comparative, not absolute, advantage is the basis for mutual gain. It doesn’t matter whether it takes Brazil more resources than the United States to make a small jet; what matters for trade is that for Brazil the opportunity cost of a small jet is lower than the U.S. opportunity cost. So Brazil, despite its absolute disadvantage, even in small jets, has a comparative advantage in the manufacture of small jets. Meanwhile the United States, which can use its resources most productively by manufacturing large jets, has a comparative disadvantage in manufacturing small jets.