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It makes predictions on the bilateral trade flows and these predictions are based on the distance within two units as well as their respective economic dimensions. During 1954 Walter Isard employed the model for the first time. It may be called a theoretical model at the basic level for the purposes of trade between couple of countries.
The equational representation of the Gravity Model of Trade is as follows:
F ij = G * Mi * Mj / D ij
In this formula G is the constant, F stands for trade flow, D stands for the distance and M stands for the economic dimensions of the countries that are being measured. The equation can be changed into a linear form for the purpose of econometric analyses by employing logarithms. In its linear form the equational representation of the Gravity Model of Trade would be as follows:
ln(Bilateral Trade Flow) = a+Ãln(Gross Domestic Product of Country1)+Ãln(Gross Domestic Product of Country2)-Ãln(Distance)+e
The Gravity Model of Trade also includes factors like colonial history between the two countries, a number variables that are used for the purpose of accounting at the level of income, which means Gross Domestic Product per capita, tariffs, levels of price, contiguity and relationships in language.
The Gravity Model of Trade has been used in a wide number of areas like international relations for example. In the area of international relations the Gravity Model of Trade has been used in order to judge the effect of alliances and treaties on the trade activities. The model has also been used to analyze the efficiency of the trade agreements and organizations such as the World Trade Organization and the North American Free Trade Agreement.
The Gravity Model of Trade has been a success from the empirical point of view. However, there have been some reservations regarding the theoretical justifications that have been put forward in favor of the model. This model is normally used in order to assess the trends in the world of global trade.
Even though the theory covers factors like spatiality and geography, it has also been used to test matters that are related to pure economics. Over the years, the Gravity Model of Trade has played an important role in the estimation of trade patterns.