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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 3 of 22
The real wordsTheory

The physics, then the trade

Newton's law of gravitation, as the deck writes it:

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

The force between two objects depends on their masses and is inversely proportional to the square of the distance between them.

The intuitive gravity equation for trade:

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

Mass becomes GDP. Distance becomes trade costs. The constant G becomes C.

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