2. The theoretical foundations of
gravity models: Newton’s Law
The model has been adapted from Newton’s laws of
gravitation
Statistically measure bilateral trade flows between
different geographical entities or regions
In the simplest gravity model, bilateral trade flows
between two countries are assumed to be
proportional to the product of their gross domestic
products
and inversely proportional to a measure of the
distance between them
3. The Two Frameworks
The Gravity Model
F = K×GDPi×GDPj
d2
F = The Flow of Trade
GDPi = GDP of country i
GDPj = GDP of country j
d = distance between
economic capitals of countries i
and j (sometimes measured by
ports).
K = is a constant.
The Newton Model
F = G×m1×m2
r2
F = The force of attraction
m1 = mass of object 1
m2 = mass of object 2
r = the distance
G = is a constant.
4. Estimated gravity equation
Newton’s Law-based Normal Trade
Normal trade
The basic equation depend upon two
major variables: GDP and distance
Positive correlation of trade to GDP and
negative correlation with distance
ln (Tradeij) = C + a ln(GDPi) + b ln(GDPj) +
+c ln(distanceij) + uij
5. “Augmenting” the gravity equations
Income per capita (higher income
countries trade more)
Adjacency
Common language, colonial links
Institutions, infrastructures, labour
flows,...
Surprisingly, bilateral tariff barriers often
missing!!!
6. “Augmenting” gravity model
Traditional approach to evaluate the impact of
RTAs: Trade creation and trade diversion
ln (Tradeij) = a ln(GDPi) + b ln(GDPj) +
+c ln(distanceij, ,adjacency, language ..) + d (Dummy i) +
+ e (Dummy j) + g (intra-RTAij)+ h (extra-RTAij) + uij
IMPORTANT the gravity model does not
estimate welfare effects
8. GDP & Distance
GDP is used to determine the size of the
country
The more the GDP, the more the trade
India’s GDP is tenth largest in the world
India’s trade with larger economies is more
Distance between India and North America is
high
High distances convert to high freight and
transportation cost
9. Common Language
Dummy variable which was augmented
on the Gravity Model
We took binary variable i.e. 0 and 1
values for having a common language
with India
Perception is that common language
increases trade between nations
11. Methodology
Data has been taken from 2003 to 2010
Demographic and GDP data :
WorldBank
Distances data: WorldAtlas
Trade data: WITS
Multiple regression using SPSS
Data available only for 19 out of 23
countries
12. The Output
Model Summary
Model R R Square Adjusted R Square Std. Error of the
Estimate
1 0.888385 0.789228 0.782317 1.149847
a. Predictors: (Constant), Population, GDP_India, Distance, Area, Language, GDP
ANOVAb
Model Sum of Squares df Mean Square F Sig.
1 Regression 905.9843 6 150.9974 114.2061 0
Residual 241.953 183 1.322148
Total 1147.937 189
a. Predictors: (Constant), Population, GDP_India, Distance, Area, Language, GDP
b. Dependent Variable: Export
13. The Output
Coefficientsa
Model Unstandardized
Coefficients
Standardized
Coefficients
t Sig.
Std. Error Beta
1 (Constant) 16.76 17.78 0.94 0.35
GDP 0.12 0.05 0.14 2.30 0.02
GDP_India 1.33 0.20 0.22 6.56 0.00
Area 0.55 0.05 0.67 10.41 0.00
Language 0.16 0.28 0.03 0.58 0.56
Distance -6.04 1.71 -0.18 -3.53 0.00
Population 0.03 0.04 0.04 0.80 0.42
a. Dependent
Variable: Export
Language and Population are not
significant
14. The Output
Model Summary
Model R R Square Adjusted R Square Std. Error of the
Estimate
Change Statistics
R Square Change F Change
1 0.887876 0.7883 0.783747 1.146065 0.788324 172.2439
a. Predictors: (Constant), Distance, GDP_India, GDP, Area
ANOVAb
Model Sum of Squares df Mean Square F Sig.
1 Regression 904.946 4.000 226.237 172.244 0.000
Residual 242.991 185.000 1.313
Total 1147.937 189.000
a. Predictors: (Constant), Distance, GDP_India, GDP, Area
b. Dependent Variable: Export
15. The Output
Coefficientsa
Model Unstandardized
Coefficients
Standardized
Coefficients
t Sig. Collinearity
Statistics
Std. Error Beta Tolerance VIF
1 (Constant) 28.108 12.651 2.222 0.028
GDP 0.144 0.043 0.172 3.312 0.001 0.425 2.354
GDP_India
1.318 0.202 0.223 6.539 0.000 0.988 1.013
Area 0.538 0.043 0.653 12.508 0.000 0.420 2.379
Distance -6.457 1.140 -0.197 -5.663 0.000 0.950 1.053
a. Dependent Variable: Export