Class_Gravity.pdf - Gravity 1/58 Application International...

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Gravity Application Brexit International Trade Theory Gravity, welfare and Brexit Mathieu Parenti November 17-24th & December 1st 1/58
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Gravity Application Brexit Table of contents Gravity Application Brexit A structural approach Non-structural approaches 2/58
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Gravity Application Brexit Once upon a time... Applied to the analysis of trade flows by Tinbergen (1962) Idea goes back to Newtonian gravity F AB = G m A m B d 2 AB The force of attraction increases in the mass of objects, decreases in the distance Works (too?) well with trade, but not only... ... useful to describe economic interactions in general. financial flows migration and even facebook 3/58
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Gravity Application Brexit Economics of Facebook 4/58
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Gravity Application Brexit Gravity Application to trade flows “There is very little that we economists fully understand about global trade but there is one thing that we do know—commerce declines dramatically with the distance. It’s not a small world.” E. Leamer (in his review of “The world is flat” by T. Friedman). Even in a globalized world, gravity reminds us that size matters borders and distance matter 5/58
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Gravity Application Brexit Size matters 6/58
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Gravity Application Brexit Distance matters 7/58
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Gravity Application Brexit Naive gravity “Typical gravity equation” between two countries is X ij = e 0 GDP 1 i GDP 2 j d β ij Take logs ln X ij = 0 + 1 ln GDP i + 2 ln GDP j - β ln d ij “log-log” specification: 1 , 2 and β are interpreted as elasticities “ A 1% increase of the distance between 2 countries decreases trade flows by β % “ If X ij corresponds to total exports from country i to country j , it is found that 1 2 β 1 8/58
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Gravity Application Brexit Naive gravity “Holding constant countries’ sizes, their bilateral trade is, on average, inversely proportional to the distance between them. “ sometimes refered to as the law of gravity. Need to think further about Market size (population, wealth, number of firms .... ) Distance (cultural, linguistic, geographic...) Trade costs (tari ff , NTB such as anti-dumping or CVDs, transport costs...) 9/58
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Gravity Application Brexit (Linguistic) Distance matters 10/58
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Gravity Application Brexit Gravity: an example 11/58
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Gravity Application Brexit Structural Gravity (introduction to Armington’s model) It is possible to derive theoretically a gravity equation. Below is one (popular) example using Krugman (1980) with n firms countries Each country supplies one homogeneous good: perfect competition between firms of a given country But imperfect substitutability of goods between country. Demand: consumers have a taste for variety as in Krugman σ > 1 is the elasticity of substitution across countries’ good. A high σ means that all varieties are similiar.
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