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Gravity with granularity

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  • Breinlich, Holger
  • Fadinger, Harald
  • Nocke, Volker
  • Schutz, Nicolas

Abstract

We evaluate the consequences of oligopolistic behavior for the estimation of gravity equations for trade flows. With oligopolistic competition, firm-level gravity equations based on a standard CES demand framework need to be augmented by markup terms that are functions of firms' market shares. At the aggregate level, the additional term takes the form of the exporting country's market share in the destination country multiplied by an exporter-destination-specific Herfindahl-Hirschman index. For both cases, we show how to construct appropriate correction terms that can be used to avoid problems of omitted variable bias. We illustrate the quantitative importance of our results for combined French and Chinese firm-level export data as well as for a sample of product-level imports by European countries. Our results show that correcting for oligopoly bias can lead to substantial changes in the coefficients on standard gravity regressors such as distance or the impact of currency unions.

Suggested Citation

  • Breinlich, Holger & Fadinger, Harald & Nocke, Volker & Schutz, Nicolas, 2021. "Gravity with granularity," LSE Research Online Documents on Economics 114419, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:114419
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    File URL: http://eprints.lse.ac.uk/114419/
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    1. Yoto V. Yotov, 2022. "Gravity at Sixty: The Workhorse Model of Trade," CESifo Working Paper Series 9584, CESifo.
    2. Georg Schneider & Frank Stähler & Georg U. Thunecke, 2022. "The (Non-)Neutrality of Value-Added Taxation," CESifo Working Paper Series 9663, CESifo.

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    More about this item

    Keywords

    gravity equation; oligopoly; CES demand; aggregative game;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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