gravity model


2019 – 20

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Writing Assignment

Total 100 marks.The purpose of this assignment is to test the gravity model of

trade, and comparing the nominal exchange rate and purchasing power

parity exchange rate (PPP) for the country of your choice. You

need to write a well-structured research report about the whole

process of acquiring and refining your

date, applying the theory and estimation, and interpreting the

results. In order to help you, your paper should include, among other things, following steps. Please note that your final paper must have a complete article structure from introduction to conclusion and references with an internal coherence.

These steps are just to help you t

o organize your paper, and also a rubric for grading, and not to be treated like questions to be answered mechanically.

Part 1)- Gravity Model of Trade: (Total 60 points)

– First you should choose a country according to the procedurein the administrative part.

– Choose a year as recent as possible.

– For the selected year, find the trade partners of the country


, you need to find enough trade partners to cover atleast 80% of the country’s total trade (asdefined in the gravity theory).Second, ifwith this condition (80% of the total trade), you ended up with less than 15 countries, find first highest15 trade partners. So, you would have at least 15 trade partners or more.

Example: Maybe, it turns out for your country of choice, in order to cover 80% of the total trade, youneed to pick 18 trade partners, so you need to use these 18 trade partners. But maybe for your countryof choice, only 12 trade partners are enough to cover 80% of the total trade. So, in this case you needto go ahead up to 15 highest trade partners anyway.)

– For the selected year and for each of the trade partners, find the bilateral import and export data, interms of current US$.


In gravity model, the size of total trade with each of trade partners, is defined as theSUM

of import and export.

(15 points)

– For the same year, find the GDP incurrent pricesfor each of the trade partners, in terms of US$.

(5 points)

– Find an appropriate distance measure between your country and each of trade partners.

(5 points)

– The trade and GDP data must be collected from reputable sources (World Bank, IMF, UN, WTO, orlocal government statistical agencies, …).

– In your writing for this part you should include the presentation of your data with proper descriptionsand also neat and informative tables and/or graphs that you cho ose; description of your data sources;


and finally mentioning possibleassumptions that you might have made in case of difficulty in datacollection and data assembly. Tables and graphs need to go tothe appendix.

(10 points)

You need to estimate the version of gravity model mentioned in Krugman textbook in order to give it more flexibility:

are the GDP of your country and jth trade partner, respectively. Tij and Dij represent the trade and distance. You have already collected all this information. On the hand a, b,and c representElasticitiesof trade with respectto the related variables.Coefficients b and c are theones that you need to estimate. By the way, K is a fixed number.

– In order to make the relation ready for estimation, let’s take natural logarithm of both sides of the

gravity equation:

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