Slide 1: This paper takes, as a startingpoint, the so-called gravity equation and it is one of the most successful empirical models in international economics.
This equation tries to explain trade flows between two countries, as afunction of GDP, distance between the two, and other related factors.
Slide 2: Nonetheless, the gravity equation presents a problem: it lacks any theoretical foundation. This has two importantimplications:
1. Since there are many factors affecting trade and correlated with the independent variables of the model, the results of the empirical estimation are likely to suffer from an omittedvariables
2. The main purpose of the gravity equation should be that of doing comparative statics exercises: this is impossible, without a theoretical framework.
Slide 3: In order to conduct acomparative statics exercise, for example asking what are the effects of removing certain trade barriers, one has to be able to solve the general-equilibrium model before and after the removal of tradebarriers. In order to do this, in the paper the autors do the following things:
1. Develop a method that is able to consistently and efficiently estimate a theoretical gravity equation,
2. Use theestimated general-equilibrium gravity model to conduct comparative statics exercises of the effect of trade barriers on trade flows,
3. Apply the theoretical gravity model to resolve the"border puzzle”, i.e. understand how much of the trade flow is explained by the presence or absence of borders.
Slide 4: The paper is structured as follows:
4. In Section I, results based on McCallum'sgravity equation are explained, both from Canada and US perspective
5. In Section II : in a simple symmetric form, the theoretical gravity equation is derived, to relate bilateral trade to...