ACADEMIC ARTICLE REVIEW

Pacu Teodora Maria, REI 934 C

The Generalized Gravity Equation, Monopolistic Competition, and the FactorProportions Theory in International Trade Jeffrey H. Bergstrand, The review of
Economics and Statistics, Vol. 71, No. 1 (Feb., 1989), 143-153
The purpose of this article is to develop a general equilibrium model of world
trade with two differentiated-product industries and two factors1 that can illustrate the
relationship between the gravity equation and the Heckscher-Ohlin model of interindustry trade and the Helpman-Krugman-Markusen model of intra-industry trade. The
study also aims at extending the microeconomic foundations for a generalized gravity
equation in Bergstrand (1985)2, so that it could assimilate factor-endowment differences.
The gravity equation is used to explain gross bilateral trade flows between pairs
of countries, taking into consideration the U.S dollar value of the flow from one country
to the other, the value of nominal GDP, the population of the two countries, the distance
between the two economic centers and any factors that may aid or may resist trade
between the two countries. Studies have been made in order to explain the empirical
success of the general equation theory in relation theories of trade that are either in favour
or against the theory, such as On Theories Explaining the Success of the Gravity
Equation by Simon J. Evenett of the World Trade Institute and Centre for Economic
Policy Research and Wolfgang Keller of the University of Texas, National Bureau of
Economic Research, and Centre for Economic Policy Research, an article that aims to
examine whether two important theories of trade, the Heckscher-Ohlin theory and the
increasing returns theory, can account for the empirical success of the so-called gravity
equation [] by conditioning bilateral trade relations on factor endowment differences3.
Other studies have made use of the generalized gravity equation theory to see the
determinants of a countrys imports, such as the study made by Mohammad Mafizur
Rahman, PhD, The Determinants of Bangladeshs Imports: A Gravity Model Analysis
under Panel Data.

In his paper, Bergstrand uses different assumptions in order to derive the

generalized gravity equation, beginning with the taste assumptions, where he uses a
bilateral version of Markusens consumer behavior model as a representative, taking into
consideration the utility function, expenditures constrained by the consumers nominal
income and the maximization of the former subject to the latter in order to generate
aggregate demand curves. He then describes the technology assumptions by using the
model of the Chamberlinian monopolistic competition, with two factors of production,
capital and labor, the technology taking linear form, under the assumption that all firms
and countries share identical technology4. He uses the constant-elasticity-function as a
model for the distribution of each firms output in the domestic and foreign markets, and
finally, the maximizing profit function. He moves on to derive the generalized gravity
equation from the mathematical functions used in the first two sections. He concludes
with the empirical estimates for a two-factor, multi-industry, multi-country world, using a
generalized version of Rybczynskis theorem5 to show that an increase in a countrys
endowment of a factor will tend to increase the output of the industries that are intensive
in that particular factor. The empirical analysis distinguishes industries by single-digit
Standard Industrial Trade Classifications (SITCs) 0 through 86, it makes use of
transport-cost factor, aggregate wholesale price indexes (WPIs), exchange rate indexes,
and base years for estimates for following years (e.g. 1960 for 1965 and 1966 estimates
and 1970 for 1975 and 1976). All empirical data are compiled in four tables that present
coefficient estimates from the generalized gravity equations.
Through this methodology, Bergstrand comes to the conclusion that by using a
two-factor, two-industry, N-country Heckscher-Ohlin-Chamberlin-Linder model,
exporter income and per capita income could be interpreted as national output in terms of
units of capital and the countrys capital-labor endowment ratio, respectively7, and also
that the generalized gravity equation explains empirically about 40% to 80% of the
variation across countries in one-digit SITC trade flows. Finally, the exporter per capita
income coefficient estimates suggest that raw materials, chemicals, machinery and
transport equipment, manufactures classified chiefly by material, and food products tend
to be capital intensive in production and that beverages and tobacco and miscellaneous
manufactures tend to be labor intensive in production. [] Manufactures tend to be

luxuries and that raw materials, fuels and chemicals tend to be necessities in
consumption.8
Personally, I believe that Bergstrands generalized gravity equation theory has
indeed succeeded in explaining the H-O trade patterns where others have not, albeit in a
limited way, because, like the H-O model, its conclusions may be hinted at with only
basic knowledge on International Trade and the subject of Economics as a whole rather
than by conducting extensive research on the subject.

Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition,

and the Factor-Proportions Theory in International Trade
2 Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition,
and the Factor-Proportions Theory in International Trade
1

Simon J. Evenett, Wolfgang Keller, On Theories Explaining the Success of the

Gravity Equation
4 Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition,
and the Factor-Proportions Theory in International Trade
5 T.M Rybczynski, Factor Endowment and Relative Commodity Prices
6 Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition,
and the Factor-Proportions Theory in International Trade
7 Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition,
and the Factor-Proportions Theory in International Trade
8 Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition,
and the Factor-Proportions Theory in International Trade
3