International Economics - Krugman
INTERNATIONAL ECONOMICS
Chapter 2 THE GRAVITY MODEL Suggest the trade between any two countries is proportional to the size of the countries (product of their GDP’s) and diminished with distance between the countries. 3 of the top 10 trading partners with the U.S. in 2005 were also the 3 largest European economies: Germany, UK, and France. These countries have the largest gross domestic product (GDP) in Europe. * GDP measures the value of goods and services produced in an economy. In fact, the size of an economy is directly related to the volume of imports and exports. Larger economies produce more goods and services, so they have more to sell in the export market. Larger economies generate more income from the goods and services sold, so people are able to buy more imports. Tij = A x Yi x Yj /Dij Tij is the value of trade between country i and country j A is a constant Yi the GDP of country i Yj is the GDP of country j Dij is the distance between country i and country j In a slightly more general form, the gravity model that is commonly estimated is Tij = A x Yia x Yjb /Dijc where a, b, and c are allowed to differ from 1. DISTANCE, BARRIERS AND BORDERS All estimated gravity models show a strong negative effect of distance on international trade. Typical estimates say that a 1% increase in the distance between two countries is associated with a fall of 0.7 to 1% in trade between those countries. This drop partly reflects increased costs of transporting goods and services. Trade agreements (NAFTA), ensures that the most goods shipped among the partner countries are not subject to tariffs and barriers. If the FTA is effective it should lead to significantly more trade among its partners than one would otherwise predict given their GDPs and distances from one another. Besides distance, borders increase the cost and time needed to trade. The negative effect of distance on trade according to the gravity models is significant, but it has grown smaller over time due to
Chapter 2 THE GRAVITY MODEL Suggest the trade between any two countries is proportional to the size of the countries (product of their GDP’s) and diminished with distance between the countries. 3 of the top 10 trading partners with the U.S. in 2005 were also the 3 largest European economies: Germany, UK, and France. These countries have the largest gross domestic product (GDP) in Europe. * GDP measures the value of goods and services produced in an economy. In fact, the size of an economy is directly related to the volume of imports and exports. Larger economies produce more goods and services, so they have more to sell in the export market. Larger economies generate more income from the goods and services sold, so people are able to buy more imports. Tij = A x Yi x Yj /Dij Tij is the value of trade between country i and country j A is a constant Yi the GDP of country i Yj is the GDP of country j Dij is the distance between country i and country j In a slightly more general form, the gravity model that is commonly estimated is Tij = A x Yia x Yjb /Dijc where a, b, and c are allowed to differ from 1. DISTANCE, BARRIERS AND BORDERS All estimated gravity models show a strong negative effect of distance on international trade. Typical estimates say that a 1% increase in the distance between two countries is associated with a fall of 0.7 to 1% in trade between those countries. This drop partly reflects increased costs of transporting goods and services. Trade agreements (NAFTA), ensures that the most goods shipped among the partner countries are not subject to tariffs and barriers. If the FTA is effective it should lead to significantly more trade among its partners than one would otherwise predict given their GDPs and distances from one another. Besides distance, borders increase the cost and time needed to trade. The negative effect of distance on trade according to the gravity models is significant, but it has grown smaller over time due to