Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World?This paper derives bilateral trade from two cases of the Heckscher-Ohlin Model, both also representing a variety of other models as well. First is frictionless trade, in which the absence of all impediments to trade in homogeneous products causes producers and consumers to be indifferent among trading partners. Resolving this indifference randomly, expected trade flows correspond exactly to the simple frictionless gravity equation if preferences are identical and homothetic, or if demands are uncorrelated with supplies, and they depart from the gravity equation systematically when there are such correlations. In the second case, countries produce distinct goods, as in the H-O Model with complete specialization or a variety of other models, and preferences are either Cobb-Douglas or CES. Here trade tends to the standard gravity equation with trade declining in distance, with departures from it that depend on relative transport costs. Conclusions are, first, that even a simple gravity equation can be derived from standard trade theories, and second, that because the gravity equation characterizes many models, its use to test any of them is suspect. |
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Armington Assumption bilateral trade flows bilateral trade patterns Bureau of Economic Cobb-Douglas preferences countries trade Deardorff 1984 derive the gravity DETERMINANTS OF BILATERAL distance from suppliers domestic Dornbusch Economic Research elasticity of substitution exporter produces exports from country factor endowments fraction Frankel frictionless gravity equation functional form H-O model Helpman homogeneous products homothetic preferences identical and homothetic impeded trade Imperfect Competition importer consumes industry intra-industry trade IR/PS Stacks HB j's relative distance Krugman monopolistic competition model NBER Working Paper NEOCLASSICAL WORLD overcome the positive P₁ pair of countries pattern of bilateral perfect competition positive transport cost producers and consumers product differentiation randomly real world Ricardian model San Diego simple frictionless gravity simple gravity equation standard gravity equation Stanley Fischer trade impediments trade theories transactions transport factor UC San Diego unequal factor prices vector volume of trade world income Yacine Aït-Sahalia YY YW zero Σκ