Modern international trade is based on the principle of?

Step 1: Analyze the question The question asks which principle forms the foundation of modern international trade, meaning the reason countries trade with one another today.

Step 2: Explain the concepts

• Absolute cost advantage (Adam Smith): A country has an absolute advantage when it can produce a good using fewer resources than another country. This is an older idea. It does not explain why trade is still beneficial when one country is better at producing everything.
• Comparative advantage (David Ricardo): A country should specialize in producing goods for which it has the lowest opportunity cost, then trade for the others. Both countries gain, even if one is more efficient at producing everything. This is the foundation of modern trade theory.
• Terms of trade: The ratio of export prices to import prices. It measures how favorable trade is for a country, but it is not a principle that explains why trade happens.
• Balance of trade: The difference between the value of a country's exports and imports of goods (visible items). It is a record, not a principle.

Step 3: Solve

• Terms of trade and balance of trade are measurements, not principles, so C and D are out.
• Absolute advantage cannot explain trade between countries where one is more efficient in everything, so it is too limited.
• Comparative advantage explains specialization and mutually beneficial trade for all countries. This is the basis of modern international trade.

Example (Nigeria and Ghana): Nigeria may be better at producing both crude oil and cocoa. If its opportunity cost of producing oil is lower, it should specialize in oil and import cocoa. Both countries end up better off.

Answer: B. comparative advantage

Exam tip: Remember "Comparative = Common benefit." If a question asks about the basis or reason for trade, think comparative advantage and opportunity cost. If it says "measure" or "record," think terms of trade or balance of trade.