Chapter 2
World Trade: An Overview
◼ Chapter Organization
Who Trades with Whom?
Size Matters: The Gravity Model
Using the Gravity Model: Looking for Anomalies
◼ Chapter Overview
Before entering into a series of theoretical models that explain why countries trade across borders and the
benefits of this trade (Chapters 3–11), Chapter 2 considers the pattern of world trade that we observe today.
The core idea of the chapter is the empirical model known as the gravity model. The gravity model is based
on the observations that (1) countries tend to trade with nearby economies and (2) trade is proportional to
country size. The model is called the gravity model, as it is similar in form to the physics equation that
describes the pull of one body on another as proportional to their size and distance.
4 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
The chapter also considers the way trade has evolved over time. Although people often feel that
globalization in the modern era is unprecedented, in fact, we are in the midst of the second great wave of
globalization. From the end of the 19th century to World War I, the economies of different countries were
quite connected, with trade as a share of GDP higher in 1910 than in 1960. Only recently have trade levels
surpassed pre–World War I trade. The nature of trade has changed, though. The majority of trade is in
manufactured goods with agriculture and mineral products making up less than 20 percent of world trade.
◼ Answers to Textbook Problems
1. We saw that not only is GDP important in explaining how much two countries trade, but also,
distance is crucial. Given its remoteness, Australia faces relatively high costs for transporting imports
2. Mexico is quite close to the United States, but it is far from the European Union (EU), so it makes sense
that it trades largely with the United States. Brazil is far from both, so its trade is split between the two.
3. No, if every country’s GDP were to double, world trade would not quadruple. Consider a simple
example with only two countries: A and B. Let country A have a GDP of $6 trillion and B have a
GDP of $4 trillion. Furthermore, the share of world spending on each country’s production is
proportional to each country’s share of world GDP (stated differently, the exponents on GDP in
Equation 2-2, a and b, are both equal to 1). Thus, our example is characterized by the table below:
Country
GDP
Share of World Spending
A
$6 trillion
60%
Chapter 2 World Trade: An Overview 5
What happens if we double GDP in both countries? Now GDP in country A is $12 trillion, and GDP in
4. As the share of world GDP that belongs to East Asian economies grows, then in every trade
relationship that involves an East Asian economy, the size of the East Asian economy has grown.
This makes the trade relationships with East Asian countries larger over time. The logic is similar to
5. As the chapter discusses, a century ago much of world trade was in commodities, which were in
many ways climate or geography determined. Thus, the United Kingdom imported goods that it could
not make itself. This meant importing things like cotton or rubber from countries in the Western