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Gravity Redux: Estimation of gravity-equation coefficients, elasticities of substitution, and general equilibrium comparative statics under asymmetric bilateral trade costs

  • Bergstrand, Jeffrey H.
  • Egger, Peter
  • Larch, Mario

A large class of models with CES utility and iceberg trade costs are now known to generate isomorphic “gravity equations.” Economic interpretations of these gravity equations vary in terms of two basic elements: the exporter's “mass” variable and the elasticity of trade with respect to true ad valorem “trade costs.” In this paper, we offer three potential contributions. First, we formulate and estimate a structural gravity equation based on the standard Krugman model of monopolistic competition and increasing returns. In the context of this model, a key parameter, the elasticity of substitution in consumption (σ), can be estimated precisely – even without observable true ad valorem trade-cost measures – using exporter's population and observable variables that influence trade costs. Second, in the empirical context of the well-known McCallum Canadian–U.S. “border puzzle,” our approach – allowing estimation of σ – yields considerably different general equilibrium comparative static trade-flow and economic welfare effects than those in an Armington endowment economy and assumed values of σ. Moreover, our predicted trade flows and GDPs are highly correlated with their respective observed values in the case of bilaterally symmetric or asymmetric Canadian–U.S. border effects. Third, a Monte Carlo analysis confirms unbiased and precise estimates of all coefficients, the elasticity of substitution, and comparative statics using our approach.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 89 (2013)
Issue (Month): 1 ()
Pages: 110-121

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Handle: RePEc:eee:inecon:v:89:y:2013:i:1:p:110-121
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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  2. Balistreri, Edward J. & Hillberry, Russell H., 2007. "Structural estimation and the border puzzle," Journal of International Economics, Elsevier, vol. 72(2), pages 451-463, July.
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  17. Huiwen Lai & Daniel Trefler, 2002. "The Gains from Trade with Monopolistic Competition: Specification, Estimation, and Mis-Specification," NBER Working Papers 9169, National Bureau of Economic Research, Inc.
  18. Bergstrand, Jeffrey H, 1985. "The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 474-81, August.
  19. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-23, June.
  20. Baier, Scott L. & Bergstrand, Jeffrey H., 2009. "Bonus vetus OLS: A simple method for approximating international trade-cost effects using the gravity equation," Journal of International Economics, Elsevier, vol. 77(1), pages 77-85, February.
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  23. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
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