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Bilateral trade volumes, the gravity equation and factor proportions

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  • Andrzej Cieślik

Abstract

The gravity equation has been widely used in studying the determinants of bilateral trade flows. Despite their dubious theoretical foundations gravity models have been extremely successful empirically. All theoretical attempts to provide a formal justification for the gravity equation assume complete specialization in production. This leads to a misleading impression that complete specialization is a necessary condition for deriving the gravity equation. In this paper we demonstrate formally that the gravity equation can be derived also from a variety of incomplete specialization models based on both neoclassical and monopolistic competition assumptions. The common prediction that emerges from these models is that factor proportion variables, along with the country size variables, play a key role in determination of bilateral trade volumes, however, their impact is model specific. The neglect of these variables in empirical studies employing gravity equations derived from complete specialization models might result in estimates that suffer from the omitted variable bias if trading partners differ in terms of their relative factor endowments.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09638190902757400
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal The Journal of International Trade & Economic Development.

Volume (Year): 18 (2009)
Issue (Month): 1 ()
Pages: 37-59

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Handle: RePEc:taf:jitecd:v:18:y:2009:i:1:p:37-59

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Related research

Keywords: bilateral trade; factor proportions; gravity equation; incomplete specialization;

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Cited by:
  1. Oxana Babecká Kucharčuková & Jan Babecký & Martin Raiser, 2012. "Gravity Approach for Modelling International Trade in South-Eastern Europe and the Commonwealth of Independent States: The Role of Geography, Policy and Institutions," Open Economies Review, Springer, vol. 23(2), pages 277-301, April.
  2. Oxana Babecka Kucharcukova & Jan Babecky & Martin Raiser, 2010. "A Gravity Approach to Modelling International Trade in South-Eastern Europe and the Commonwealth of Independent States: The Role of Geography, Policy and Institutions," Working Papers 2010/04, Czech National Bank, Research Department.

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