History of Gravity Model
The Gravity model brings to light one of the most stable relationships in economics: the interaction
between two large economies is stronger as opposed to the one between a smaller one, and the other being
the fact that nearby countries tend to attract more trade compared to the ones further off. Even though the
model is in all likelihood is widely known in the context of international trade and capital flows between
countries, it has also been effectively implemented to find how patients flow between hospitals and even
how students tend to move about in different universities.
Based on The Law of Universal Gravitation (Newton, 1687), Jan Tinbergen developed The Basic Gravity
Equation (Tinbergen, 1962) which has led to a richer and more accurate estimation and interpretation of
the trade flows between two specific nations. In the case of the Gravity Model, "distance" carries an
extensive meaning. It not only refers to the physical distance in kilometers as an approximation of
transport costs but also considers more subtle Economic factors such as ad Valorem tariffs and non-tariff
barriers.
Description of the Model
The Gravity Model is used to model trade flows between two countries. These can refer to a number of
things such as Foreign Direct Investments, Migrations, and Trade. The Basic Gravity Equation for trade
developed by Jan Tinbergen looks like this:
X = G. M.N/D
In this equation, the variable X is used to describe the volume of trade between the two countries. M and
N stand for the Gross Domestic Product of the two respective nations. The gravitational constant and the
distance between the countries are denoted by the constants G and D respectively.
The volume of trade is determined by several factors. For starters, The Gravity Model shows us that
countries with large GDP tend to trade more with each other. Large economies tend to have a higher
Income/GDP per capita and thus are capable of exporting large quantities. On the flip side, higher income
per head makes the consumers demand more foreign goods, increasing the imports. A large economy
tends to attract a bigger share of other country’s spending as they have a vast range of products they can
produce efficiently. In addition to these, there are other factors such as cultural ties between nations such
as a common language or religion, which may affect trade. Geography and International Borders also play
a part in determining the volume of trade that occurs. The existence of ports and lack of mountains and
forests enhances trade whereas international boundaries increase the “distance” between the two
countries, thus making the process time-consuming. The formation of free trade areas tends to speed up
the process thus bolstering trade between countries. It is suggested that since 2017, Exports of goods from
the UK (EU) to the EU (UK) are expected to fall between 7.2 percent and 45.7 percent (5.9 percent and
38.2 percent) six years after the Brexit. The negative trade consequences in the UK are only partly offset
by a rise in domestic goods trade and trade with third countries, resulting in a real income drop of
between 1.4 and 5.7 percent in the hard Brexit scenario. The predicted welfare effects for the EU are
insignificant in magnitude and statistically insignificant (Oberhofer, Pfaffermayr, 2017). Last but not
least, the existence of Multinational Corporations can bring about large volumes of trade as raw materials
and goods are often imported and exported between the nations.
Evolution of the Model
Economists have widely used the gravity model to try to explain the pattern of trade in a globalized
world. Jan Tinbergen suggested in 1962 that the scale of bilateral trade flows between any two countries
could be approximated by using the ‘gravity equation,' which is derived from Newton's theory of
gravitation. Countries, like planets, are drawn to each other in proportion to their size and proximity.
Current GDP determines the relative scale, while trade costs determine economic proximity – the more
economically ‘distant,' the higher the trade costs.
The gravity model proposes that overall financial size pulls in nations to exchange with one another while
more prominent distances debilitate the engaging quality. At first, the gravity model was viewed as an
exact one, with no specific establishing in exchange hypothesis, yet the far-reaching appropriation of the
gravity model to clarify examples of exchange has been seen by financial specialists as a critical
advancement on past hypothetical models.
These include the Ricardian model, which describes trade patterns in terms of differences in technology
distribution, and the Heckscher-Ohlin model, which bases trade on differences in factor endowments
between countries. The scale of an economy was not considered important in these pre-gravity models.
The soundness of the gravity condition and its capacity to clarify respective exchange streams prompted
the improvement of hypotheses that could consolidate the model. The gravity model is presently seen as
the workhorse of the exchange hypothesis, and particularly regarding estimating the effect of changes in
exchange strategy on exchange costs. The model is adaptable in that 'distance' between nations can
incorporate a scope of applicable factors, including social and political contrasts between exchanging
countries.
