A Theoretical Foundation for the Gravity Equation

Abstract

The intent of this paper is to provide a theoretical explanation for the gravity equation applied to commodities. It uses the properties of expenditure systems with a maintained hypothesis of identical homo thetic preferences across regions. Products are differentiated by place of origin (for a justification, see Peter Isard). The gravity model constrains the pure expenditure sys tem by specifying that the share of na tional expenditure accounted for by spend ing on tradeables (openness to trade) is a stable unidentified reduced-form function of income and population.