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Suppose that trade volume between any pair of countries i and j, Tij, is given by the following gravity model: Tij = 2 * Yi *

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Answer #1

a)

Z = 0.005

Tij = Z*Yi*Yj / Dij

Trading Volume between A and B = Z*Yi*Yj / Dij

= 0.005 *12000 * 14000 / 100

= 8400

Trading Volume between A and C = Z*Yi*Yj / Dij

= 0.005 * 12000 * 21000 / Dij

= 12,60,000/ Dij

Both Trade Volumes are equal. So,

12,60,000/ Dij = 8400

Dij = 150

So, Distance between A and C = 150

(b)

According to the Gravity Model, the trade volume depends upon the GDP of two countries and the distance between them.

Trade Volume is positively related with Countries GDP. This is also in line with other trade models. A country having higher GDP has the potential to increase its exports in other nations. Also, a higher income implied by the higher GDP increases international trade as well.

(c)

Z is a constant in the gravity model equation. I think if all the three countries sign a free trade agreement, there would no change in the constant Z.

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