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which has been used intensively in analyzing patterns and performances of international trade in recent years. can be applied to quantify the trade flows empirically.The classical and new trade theory can successfully explain the reasons for countries to join in world trade. however they cannot answer the question of the size of the trade flows. . the gravity model.

Therefore in recent years there has been increasing interest in providing the theoretical support for the gravity model. The name comes from the analogy to Issac Newton’s law of gravity. where the force of attraction between two bodies depends on the bodies’ masses divided by the squared distance. .The gravity model has long been criticized for lacking in theoretical foundation.

it is not strange to have many variations of gravity equation. WHICH IS USUALLY MEASURED AS THE STRAIGHT LINE DISTANCE BETWEEN THE COUNTRIES’ GEOGRAPHIC CENTERS. GNP OR GNP PER CAPITA. the gravity model shares some common features :- GRAVITY MODEL IS APPLIED TO EXPLAIN BILATERAL TRADE. THE IDEA BEHIND THIS IS COUNTRIES WITH HIGHER INCOME TEND TO TRADE MORE AND THOSE WITH LOWER INCOME TRADE LESS. . DISTANCE IS ANOTHER VARIABLE. However. THE DEPENDENT VARIABLE IS ALWAYS THE TRADE VARIABLE. THE ECONOMIC MASS OF EXPORTING AND IMPORTING COUNTRY ARE MEASURED BY GDP OR GDP PER CAPITA.There are huge numbers of empirical applications of gravity model. DUMMY VARIABLES ARE ALWAYS INCLUDED IN ORDER TO INVESTIGATE THE QUALITATIVE VARIABLES. ALSO A PROXY FOR TRANSPORT COST.

Yi. The general gravity model applied in bilateral trade has the following form :- Tij =(A.Yj )/ Dij .Tinbergen first applied this gravity model to analyze international trade flows in 1962 and many others had followed to set up a series of econometric model of bilateral trade flows.

” .(2003) state “the elasticity of trade volumes with respect to distance is usually estimated to be in the interval -0. •Distance between nations and trade flows have a negative relationship.5.” Overman et al.6. The Gravity Theory essentially suggests that distance tend to create barriers leading to higher costs.WHAT DOES THE THEORY SAY? •The simplest theoretical proposition of the gravity model is that bilateral trade flows between two nations tends to be directly proportional to the product of their respective GDPs and inversely proportional to their distance measure. Hence. Leamer and Levinsohn(1995) mention two early studies and then claim “These and many subsequent studies have found a distance elasticity of about -0.9 to -1.higher the trade volume and vice versa. higher the GDP ratio .

The Border Effect : This says that national borders impedes trade. Unilaterally raised barriers could be minimized through bilateral agreements. Thus country borders seem to matter a lot to retard trade.According to the Gravity Theory other factors that might affect bilateral trade flows are : Cultural Distance-differential among nations. Administrative Differences and Bureaucratic hurdles. . Such results have been found in other parts of the globe as well. Empirical results about trade between regions in Canada and in the USA are remarkable since they show that intranational trade is dramatically higher than international trade.

.

with a weighted mean eﬀect of 1. Both the role of distance and economic size are remarkably stable over time. and using various econometric methods. •Research by different economists over the last few decades have revealed that there is some amount of dispersion in the estimated distance coeﬃcient. the distance coeﬃcient has been remarkably stable. •Despite this dispersion.55.07 and 90% of the estimates lying between 0. across different countries.The empirical evidence for the gravity equation in international trade is strong. . hovering around 1 over more than a century of data .28 and 1.

48 11 14350.86 248 4539.31 76 5021.59 126.21 997 3646.59 2330 14791.49 335 5244. Eu) LIBYA 1116 BAHRAIN 1179 PHILLIPINES 1253 ARGENTINA 1329 MOROCCO 1434 AZERBAIJAN 1438 MYANMAR 1460 ALGERIA 1600 TANZANIA 1619 JORDAN 1623 YEMEN 1683 COLOMBIA 1801 PAKISTAN 1810 BAHAMAS 1890 UKRAINE 2359 CHILE 2442 NEPAL 2647 KENYA 3025 OMAN 3357 SRILANKA 3530 CANADA 3591 TURKEY 3686 MEXICO 3966 EGYPT 4271 BANG'DESH 4329 VIETNAM 4351 ISRAEL 4844 RUSSIA 5242 ANGOLA 6645 THAILAND 6964 BRAZIL 8987 VENEZ'LA 9579 S.66231 3.98 364 3637.AFRICA 10120 MALAYSIA 11030 AUSTRALIA 12038 IRAN 12443 QATAR 13155 S.96 1125 4636.47 b2(dist) b1(GDP) a(const) -0.38 1446 11481.5 7699.25 126.747794 9990.062896 .4 4616 5965.52 2486 4991.52 500 15989.49 171 8472.08 306 1223.53 74 5888 38.21 7562.$) Distance(k.5 1013.2 1429.7 4403.7757307 Correlatiob b/w trade and distance= -0.86 402 15217.79 91 2393.28 492 3087.69 320 3193.m) 88 6532.6 57.86 515 1454.76 32.02 155 3751.51 40.4 2960 417 4630.43 747 15944.9 646 2385.51 89 1768.79 1212 4490.36 1758 15111.23 274.KOREA 13955 KUWAIT 14694 JAPAN 14955 HONGKONG 15388 INDO'SIA 15564 IRAQ 16006 GDP(bil.TRADE WITH INDIA Trade(in mil.17 579 8264.57 961 7822.31 538 4929.8 3265.11 319 16710.15 189 2890.348 Correlation b/w trade and gdp=0.65 98 3685.47 1622 4693 166 3310.

TRADE-GDP REGRESSION LINE .

TRADE-DISTANCE REGRESSION LINE .

European Commission .Size of European Nations and their trade with the USA Source-U.S Department of Commerce.

U nations and neighboring countries Source-U.S Department of Commerce.Comparing Trade with E. European Commission .

MORE ON THE GRAVITY EQUATION .

With the increasing advancement of technology .but never zero. .which states that Gravity between two bodies can be very small .GRAVITY DEFYING TRADE A basic flaw of the Gravity Equation is the analogy with the Newtonian Gravity equation .transportation has become extremely convenient . We know . The existence of observations for which the dependent variable is zero creates a problem for use of the log-linear form of the gravity equation . But empirical data has clearly shown even now trade has a strong negative correlation with distance.that it is absolutely possible that two countries might not be engaged in any kind of mutual trade.and the role of distance on trade should have diminished.however . The Achilles Heel of the Gravity Theory is its inability to explain the effect of distance on trade.

Yj. stochastic versions of the equation are used in empirical studies. gives the Gravity Equation where ηij is an error term with E(ηij |Yi. Yj. assumed to be statistically independent of the regressors.The analogy between trade and the physical force of gravity. To account for deviations from the theory. clashes with the observation that there is no set of parameters for which the gravity equation will hold exactly for an arbitrary set of observations. leading to E(Tij |Yi. Dij) = 1. however.(2) . Tij = α0Y α1i Y α2j Dα3ij ηij ……(1). There is a long tradition in the trade literature of log-linearizing (1) and estimating the parameters of interest by least squares using the equation ln (Tij) = ln(α0) + α1 ln (Yi) + α2 ln (Yj) + α3 ln (Dij) + ln(ηij)…….. Dij) = α0Y α1i Y α2j Dα3ij .

or Dij . if the variance of the error term ηij in equation (1) depends on Yi.The validity of these procedure depends on the assumption that ƞij . the expected value of ln(ηij) will also depend on the regressors. are statistically independent of the regressor. . and therefore ln(ƞij). This is because the expected value of the logarithm of a random variable depends both on its mean and on the higher order moments of the distribution. Hence. violating the condition for consistency of OLS. for example. Yj.

Effect of Trade Policy : It is a large research programme to test for the effects of trade policy. .USES OF THE GRAVITY EQUATION To test for dispersion relationship : The gravity equation helps us establish that similar countries(in GDP terms) should trade more with each other rather than with dissimilar countries. Generally. In gravity equations one sometimes include dummy variables for membership of free trade organizations. Countries with low trade barriers between them trade more than do other countries. such regressions indicate that trade policy is important for international trade. Thus country borders retard trade. Country Borders : Empirical research about trade between regions in Canada and between regions in Canada and in the USA show that intra-national trade is dramatically higher than international trade. This is so also for USCanadian trade which is one example of two highly integrated countries.

e. .CONCLUSION The GRAVITY EQUATION of trade has achieved what the Ricardian Model or the H-O model could not . Even in the 21st century . the equation has shown immense empirical strength . Although the theoretical basis of the model is lacking . .i.we can only hope that the Gravity Equation will become a more mainstream theoretical model in Trade Theory .to quantify trade flows.with the advancement of research and economical studies .

eu.ec.Reference– Wikipedia.net trade.com Distancefromto.org .europa.

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