Model Answer
0 min readIntroduction
The gravity model of trade, borrowed from Newton’s law of universal gravitation, posits that trade between two countries is directly proportional to the size of their economies and inversely proportional to the distance between them. Developed by Jan Tinbergen in 1962 and further refined by Poyhonen in 1963, this model provides a simple yet powerful framework for understanding the volume of trade flows. It’s based on the idea that larger economies tend to trade more, and trade is hindered by geographical distance, reflecting transportation costs and other barriers.
Core Principles and Mathematical Formulation
The basic gravity model can be represented as:
Tij = k * (Yi * Yj) / Dij
Where:
- Tij = Trade flow between country i and country j
- k = Constant of proportionality
- Yi = GDP of country i
- Yj = GDP of country j
- Dij = Distance between country i and country j
This equation suggests that trade increases with the product of the GDPs of the two countries and decreases with the distance between them. The GDP represents the ‘mass’ of each economy, analogous to the mass in Newton’s law.
Determinants of Trade – Size and Distance
Economic Size: Larger economies, with higher GDPs, have greater purchasing power and production capacity, leading to increased demand for imports and greater export supply. This directly translates into higher trade volumes. For instance, trade between the US and China is significantly higher than between Luxembourg and Iceland due to the vast difference in their economic sizes.
Distance: Distance acts as a proxy for transportation costs, communication costs, and other barriers to trade. Greater distances increase these costs, making trade less competitive. The impact of distance is often modeled using a power function, making the relationship non-linear. For example, trade between neighboring European countries is far more extensive than trade between Europe and Australia.
Beyond Size and Distance – Extensions and Limitations
The basic gravity model has been extended to incorporate other factors influencing trade, such as:
- Border Effects: Countries sharing a border tend to trade more.
- Language: Common language facilitates trade.
- Colonial Ties: Historical colonial relationships often foster trade.
- Trade Agreements: Preferential trade agreements boost trade between member countries.
However, the model has limitations. It doesn’t fully account for factors like product differentiation, non-tariff barriers, exchange rate fluctuations, or the role of multinational corporations. Furthermore, it assumes homogeneity of products and doesn’t consider the specific composition of trade.
Conclusion
The gravity model of trade remains a valuable tool for understanding the broad patterns of international trade. While its simplicity necessitates certain assumptions, it provides a useful benchmark for predicting trade flows and analyzing the impact of factors like distance and economic size. Modern trade models build upon this foundation, incorporating more complex variables to provide a more nuanced understanding of global trade dynamics.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.