EFB336 Chap.1 World Trade and the Gravity Model
World Trade and the Gravity Model
World trade is unevenly distributed across partners, products and distance. The gravity model organises that pattern by predicting larger flows between large economies and smaller flows when trade resistance is high. Logarithms turn its multiplicative form into an estimable equation whose coefficients can be read as elasticities.
A complete interpretation also recognises borders, language, agreements and multilateral resistance rather than treating physical distance as the only cost.
What this chapter covers
- 01
World trade patterns and interdependence
- 02
Economic mass in the gravity relationship
- 03
Distance and broader trade resistance
- 04
Log-linear equations and elasticities
- 05
Borders, language and agreement indicators
- 06
Multilateral resistance and conditional interpretation
Worked example · free
Interpret a log gravity coefficient
- +1The log-log coefficient is an elasticity, so multiply 0.8 by the 10% income change.
- +10.8 × 10% = 8%, giving the approximate predicted trade response.
- +1State the ceteris paribus condition because partner income and trade resistance are held fixed.
Key terms
- Economic mass
- The income or expenditure scale that raises the potential value of trade between two markets.
- Trade resistance
- Any border-related, policy or information cost that makes exchange across markets harder.
- Elasticity
- The percentage response of one variable to a one-percent change in another variable.
World Trade and the Gravity Model FAQ
Why is distance negative in a gravity equation?
Distance proxies transport, information, coordination and other separation costs. When the structural equation places distance in the denominator, its logarithm enters with a minus sign. The coefficient should be interpreted conditionally because other barriers and each country’s alternative partners also affect trade.
Why take logarithms of the gravity model?
Logs turn multiplication into addition and exponents into coefficients. This creates a regression-friendly specification and permits elasticity interpretations. The transformation does not remove the need to consider zero trade flows, omitted resistance variables or whether the empirical method matches the data.
What is multilateral resistance?
A bilateral flow depends on how difficult each country finds trading with every possible partner. Two countries may trade more with one another when their outside options become costly, even if their own bilateral distance is unchanged. Country-time controls are one way to capture that context.
Exam move
Build this topic in four passes. First, reproduce the multiplicative equation from memory and explain why income enters positively while distance or trade resistance enters negatively. Label every symbol before taking logs. Second, perform the log transformation one factor at a time. Products become sums, powers become coefficients and a denominator becomes a negative term.
Check the transformed equation by converting it back into the original multiplicative form. Third, practise numerical interpretations. If an income elasticity is 0.8 and income changes by 10%, calculate an approximate 8% trade response and state which other variables are held fixed.
If the distance coefficient is negative, distinguish the sign written in the regression from a structural distance exponent that was defined as positive before the minus sign. Fourth, develop the empirical critique. Make a table of border, common language, colonial relationship, agreement membership, product composition and country-time conditions.
For each variable, state whether omitting it could be correlated with distance or market size. Explain multilateral resistance through a concrete comparison: a pair may trade more when every alternative partner becomes harder to reach even though the pair’s own distance has not changed.
Draw the course figure again with two large markets, one nearby small market and changing outside routes, then narrate what the network adds beyond a bilateral line. Finish revision with three answer forms: a two-sentence coefficient interpretation, a paragraph evaluating an estimated distance effect, and an essay plan comparing descriptive fit with causal explanation.
A complete response should identify the equation, interpret signs and elasticities, qualify the estimate and connect the bilateral result to the wider trading system.
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