Gravity Model of Trade
Trade flows predicted by size and distance, the most empirically successful model in economics.
The Gravity Model of Trade model, in writing
Definition
Trade between two countries scales with the product of their economic sizes and shrinks with the distance between them, an empirical law as reliable as any in economics.
Trade_ij = A · (GDP_i · GDP_j) / Distance_ij^θ
The intuition
Big economies produce and buy more of everything, and distance still costs real money in freight, time, and information frictions. The model fits trade data astonishingly well and doubles as a measuring device: borders, common language, and trade agreements show up as gravity 'bonuses', letting economists price the effect of policy in kilometres.
Exam tip
Log-linearize it: ln(trade) = ln A + ln GDPi + ln GDPj − θ·ln(distance), ready for regression. The distance elasticity θ ≈ 1 is the number worth quoting.
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