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Sem 5 Prep
← Intl TradeThe gravity model of trade

Formulas for this chapter

Gravity force in physics (the analogy)

F(ij) = G x M(i) x M(j) / d(ij)^2

Quote it to set up the analogy, and to make the point that the trade version does not square its denominator.

F(ij)
Force between objects i and j
G
Gravitational constant
M(i), M(j)
Masses of the two objects
d(ij)
Distance between them, squared in the denominator

Intuitive gravity model of trade

X(ij) = C x Y(i) x Y(j) / t(ij)

The main equation of this chapter. Use it whenever a question gives two GDPs and a measure of trade costs or distance, or asks what happens to trade when one of those changes.

X(ij)
Exports or trade from country i to country j
C
Constant, estimated from data; carries the units
Y
Economic mass, in practice GDP
t(ij)
Bilateral trade costs: distance, adjacency and policy factors

Gravity model, textbook form

T = C x Y(1) x Y(2) / D

The textbook's version, with distance in place of trade costs. Identical logic; use it when the question gives kilometres rather than a cost index.

T
Value of trade between countries 1 and 2
D
Distance between them, first power

Estimating the constant

C = T x D / (Y(1) x Y(2))

When one country pair's trade is observed and you must predict another pair. Fit C first, keep four or five significant figures, then substitute the second pair.

T
Observed trade for the benchmark pair
D
Distance for the benchmark pair, in the same units you will reuse
Step 1 of 22
The ideaTheory

Two magnets on a table

Put two magnets on a table. The pull between them depends on two things: how strong each magnet is, and how far apart they are.

Trade behaves the same way. Two big economies close together trade a lot. A big one and a tiny one far apart trade very little.

That is the whole intuition, and somebody wrote it down as an equation in 1962. It is still the most used equation in empirical trade.

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