Undertstanding the Home Market Effect and the Gravity Equation: the Role of Differentiating Goods

33 Pages Posted: 9 Feb 1999 Last revised: 11 Oct 2010

See all articles by Robert C. Feenstra

Robert C. Feenstra

University of California, Davis - Department of Economics; National Bureau of Economic Research (NBER)

James R. Markusen

University of Colorado at Boulder - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Andrew Kenan Rose

University of California - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: November 1998

Abstract

This paper argues that the theoretical foundations for the gravity equation are general, while the empirical performance of the gravity equation is specific to the type of goods examined. Most existing theory for the gravity equation depends on the assumption of differentiated goods. We show that the gravity equation can also be derived from a reciprocal dumping' model of trade in homogeneous goods. The different theories have different testable implications. Theoretically, the gravity equation should have a lower domestic income elasticity for exports of homogeneous goods than of differentiated goods, because of a home market' effect which depends on barriers to entry. We quantify the home market effect empirically using cross-sectional gravity equations, and find that domestic income export elasticities are indeed substantially higher for differentiated goods than for homogeneous goods.

Suggested Citation

Feenstra, Robert C. and Markusen, James R. and Rose, Andrew Kenan, Undertstanding the Home Market Effect and the Gravity Equation: the Role of Differentiating Goods (November 1998). NBER Working Paper No. w6804. Available at SSRN: https://ssrn.com/abstract=140605

Robert C. Feenstra (Contact Author)

University of California, Davis - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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James R. Markusen

University of Colorado at Boulder - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER) ( email )

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Andrew Kenan Rose

University of California - Haas School of Business ( email )

Berkeley, CA 94720
United States
510-642-6609 (Phone)
510-642-4700 (Fax)

HOME PAGE: http://faculty.haas.berkeley.edu/arose

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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