Question

Let’s get some more practice with the gravity model. Make sure to show your work in your answers to the questions below. Recall that for any pair of countries H and F, the amount of trade between them, TH,F, can be predicted by

where A is a constant (let’s assume in these examples it equals 0.02); GDPH and GDPF are home and foreign GDP, respectively, measured in billions of US dollars; DISTH,F is the distance in miles between the two countries; and TH,F is the total amount of trade in billions of dollars. Note that "the total amount of trade" between the two countries is Exports + Imports, when looked at from one country’s point of view, and Imports + Exports, when looked at from the other country’s point of view.

Consider these 4 country pairs:

Country Pair


GDPH


GDPF


DISTHF


Country Pair

1


21000


3200


4300


US-UK

2


21000


2000


1200


US-CAN

3


21000


2400


1200


US-MEX

4


360


490


500


Vietnam-Thailand

1. How much trade do we predict for pairs 1, 2, 3, and 4?

2. Compare you answers for pairs 2 and 3 (which are, of course, US trade with our two closest neighbors, basically the same distance from us but having different GDPs). How much extra trade arises for the US with Mexico, over and above the US trade with Canada, expressed in percentage terms? Explain why US trade with Mexico is predicted to be bigger than US trade with Canada.

3. Now focus on pair 4, Vietnam and Thailand. By how much must Vietnam’s GDP grow—all things equal--for us to predict that trade would double (i.e. rise by 100%)? By how much would Thailand’s GDP need to grow to raise its trade with Vietnam by $5 billion, again all else equal? By how much would their trade change (%) if both their GDPs fell by 5% next year (2022) due to a resurgent pandemic?

Answer 1

1. The predicted trade for each pair using the gravity model is as follows:

- Pair 1 (US-UK): Approximately $312.56 billion

- Pair 2 (US-CAN): $700 billion

- Pair 3 (US-MEX): $840 billion

- Pair 4 (Vietnam-Thailand): $7.056 billion

Now, let's move on to the next questions.

2. The trade between the US and Mexico is predicted to be 20% higher than the trade between the US and Canada.

This is primarily due to the difference in GDP between Mexico and Canada. Despite the distance between the US and both countries being the same, Mexico's higher GDP leads to a higher predicted trade volume according to the gravity model. The gravity model suggests that larger economies tend to trade more with each other, all else being equal.

Now, let's move on to the third question.

3. For the trade between Vietnam and Thailand to double (i.e., increase by 100%), Vietnam's GDP would need to grow by approximately 100%.

To increase its trade with Vietnam by $5 billion, Thailand's GDP would need to grow by approximately 70.86%.

If both Vietnam and Thailand's GDPs fell by 5% in 2022 due to a resurgent pandemic, their trade would decrease by approximately 9.75%.