Lecture 1.

2 International Economics: Theory and

The Gravity Model of International Trade
Policy
Eleventh Edition

The Pattern • Who trades with whom

of Trade
Chapter 2

The Gravity
•
•
Size matters
Distance also matters World Trade: An
Model •
•
What other factors affect world trade?
Summary in a formula Overview

Distance and • The “border puzzle”

Borders • Example: US and Canadian trade

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Figure 2.1 Total U.S. Trade with Major Partners, 2015

Who Trades with Whom?
• Can you predict which countries are the largest
trading partners of the US?
• The 5 largest trading partners with the U.S. in 2015
were China, Canada, Mexico, Japan and Germany.
• The total value imports from and exports
to China in 2015 was about $600 billion dollars.
• The largest 15 trading partners with the
U.S. accounted for 75% of the value of U.S. trade in
2015.
• See Figure 2-1.
U.S. trade—measured as the sum of imports and exports—is mostly
with 15 major partners.
Source: U.S. Department of Commerce.
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 The Gravity Model: Size Matters The Gravity Model: Size Matters
• As a first approximation, the size of an economy
• Let us now keep distance from the US (more or less) should be directly related to the volume of its imports
fixed: consider only European countries. and its exports.
• 3 of the top 10 trading partners with the US  Larger economies produce more goods and
in 2015 were also the 3 largest European economies:
Germany, United Kingdom, and France. services, so they have more to sell in the export
market.
• These countries have the largest gross domestic
product (GDP) in Europe.  Larger economies generate more income from
the goods and services sold, so people are able
 GDP measures the value of goods and services to buy more imports.
produced in an economy.
• Why does the US trade mostly with these and not  However, how would you critique these
other European countries? statements?
• See Figure 2-2.

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Fig. 2-2: The Size of European Economies, and the Gravity Model: what else affects trade?
Value of Their Trade with the United States
Other things besides size matter for trade:
1. Distance should matter: why?
• Distance between markets influences transportation
costs and therefore the cost of imports and exports.
• Distance may also influence personal contact and
communication, which may influence trade.
2. Cultural affinity should matter: why?
• Cultural and ethnic ties between two countries
facilitate economic ties.
• Example: Rauch and Trindade, “Ethnic Chinese
Networks in International Trade,” Review of
Economics and Statistics 2002.
3. Geography: ocean harbors and a lack of mountain
Source: U.S. Department of Commerce, European Commission
barriers make transportation and trade easier.
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 Gravity Model: what else affects trade? Gravity Model: summary in a formula
4. Multinational corporations: corporations spread across
different nations import and export many goods between • The gravity model summarizes all of this information.
their divisions. Example: Kei-Mu Yi, “Can Vertical • In its most basic form, it assumes that only size and
Specialization Explain the Growth of World Trade,” JPE distance are important for trade:
2003.
Tij = A x Yi x Yj /Dij
5. Borders: crossing borders may involve formalities that
• where
take time and perhaps money (tariffs).
Tij is the value of trade between country (or “economy”)
 These implicit and explicit costs reduce trade.
i and country / economy j
 The existence of borders may also indicate the
A is a constant
existence of different languages or different
currencies, further impeding trade. Yi the GDP of country / economy i
 Example: John McCallum, “National Borders Matter: Yj is the GDP of country / economy j
Canada-US regional Trade Patterns,” AER 1995. Dij is the distance between country / economy i and
 Example: James E. Anderson and Eric van Wincoop, country / economy j
“Gravity with Gravitas: A Solution to the Border
Puzzle,” AER 2003. 1.2-slide 9 1.2-slide 10

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Figure 2.3 Economic Size and Trade Distance and Borders

with the United States

• Yet even with a free trade agreement between

the US and Canada, which use a common
language, the border between these countries
still seems to be associated with a reduction
in trade.
• See Figure 2-4.
• This is called the “border puzzle”.
The United States does markedly more trade with its neighbors than it
does with European economies of the same size.
Source: U.S. Department of Commerce, European Commission.

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 Fig. 2-4: Canadian Provinces and U.S. States Table 2.1 Trade with British Columbia,
That Trade with British Columbia as Percent of GDP, 2009
U.S. State at Similar
Canadian Trade as Trade as Distance From British
Province Percent of GDP Percent of GDP Columbia
Alberta 6.9 2.6 Washington
Saskatchewan 2.4 1.0 Montana
Manitoba 2.0 0.3 California
Ontario 1.9 0.2 Ohio
Quebec 1.4 0.1 New York
New Brunswick 2.3 0.2 Maine

Source: Statistics Canada,

U.S. Department of
Commerce.
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