The Gravity Model

The Gravity Model

Introduction

  • Focuses on factors influencing international trade

  • Presented by Alessia Lo Turco for the International Economics course, academic year 2024-2025.

Key Factors Relevant to International Trade

  1. Market Size (GDP)

    • Larger GDP indicates larger markets for trade.

  2. Distance Between Markets

    • Affects transportation costs and impacts the feasibility of trade.

    • Influences personal contacts and communication between trading partners.

  3. Cultural Affinity

    • Countries with shared cultural ties tend to have stronger economic ties.

  4. Geographical Factors

    • Access to the sea promotes easier trade, while mountain barriers can hinder it.

  5. Multinational Corporations

    • They hold significant importance as they drive imports and exports across borders through their affiliates.

  6. Borders

    • Borders entail additional time and costs, represented by tariffs and required paperwork, which diminish trade volumes.

    • Language differences and currency variations can further complicate trade.

The Gravity Model Formula

  • The basic model is represented as:

    Tij = A x Yi x Yj / Dij

    • Tij: Trade value between country i and j

    • A: Constant

    • Yi, Yj: GDPs of countries i and j

    • Dij: Distance between countries i and j

Extended Gravity Model

  • A more generalized version of the model:

    Tij = A x Yi^a x Yj^b / Dij^c

    • where a, b, and c can vary from 1.

    • This model effectively predicts actual trade flows.

Impact of Distance and Borders

  • A 1% increase in distance correlates with a 0.7%-1% decline in trade volume.

  • Borders not only reduce trade volume but can also increase the overall cost and time involved in trade.

  • Trade agreements aim to simplify these formalities to enhance trade.

Example: NAFTA

  • The North American Free Trade Agreement (NAFTA), established in 1994, led to increased trade volume between the U.S., Canada, and Mexico compared to trade with European countries.

  • Despite common language and free trade, borders still inhibit trade volume between the U.S. and Canada.

Technology's Influence on Trade

  • Advances in technology have reduced the negative impact of distance over time, facilitating global trade through improved communication and transportation methods such as:

    • Wheels, sails, internal combustion engines, telephones, airplanes, and the internet.

Log-linearized Gravity Model

  • The log-linear form of the gravity model:

    lnTij = lnA + axlnYi + bxlnYj – cxlnDij