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Border Effects and the Gravity Equation: Consistent Methods for Estimation

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  • Robert C. Feenstra

Abstract

The CES monopolistic competition model is an especially convenient way to derive the gravity equation, especially when we allow for transport costs and other trade barriers. In that case, we need to take account of the overall price indexes in each country. We review three methods to do so: using published data on price indexes; using the computational method of Anderson and van Wincoop; or using country fixed effects to measure the price indexes. The latter two methods are compared on the dataset dealing with trade between and within Canada and the US. The fixed effects method produces consistent estimates of the average border effect across countries, and is simple to implement, so it might be considered to be the preferred estimation method.

Suggested Citation

  • Robert C. Feenstra, 2002. "Border Effects and the Gravity Equation: Consistent Methods for Estimation," Scottish Journal of Political Economy, Scottish Economic Society, vol. 49(5), pages 491-506, November.
  • Handle: RePEc:bla:scotjp:v:49:y:2002:i:5:p:491-506
    DOI: 10.1111/1467-9485.00244
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