Gravity Model and the Extensive Margin of Trade

In this paper, I have attempted to assess the relationship that links distance and varieties of goods that are being traded between countries which in the framework of the Gravity model of trade is called the Extensive margin. After studying relevant literature, I have proposed two hypotheses that firstly, this relationship exists and secondly, it is negative. The existing literature mostly examines the extensive margin on small scales by investigating trade flows of a particular large country such as the United States, only some do examine just OECD and other trade unions’ data. The main result of this paper is the approval of negative relationship between distance and the extensive margin with data, incorporating 166 countries from the entire world. For precision of findings a recently elaborated data on weighted distances was used instead of traditional capital-to-capital distances. Following the major works in this field of study, I have constructed a fixed factors econometric model. I have used two different approaches to the estimation: Ordinary Least Squares and Ordered Probit. Both methods are essential, because the first one is allows for wider interpretation and the second one is more correct with reference to the nature of dependent variable. To stress the significance test more, I have added a set of mutual factor variables that characterize each pair of countries. In both methods the distance variable was highly significant and yielded consistent negative effect on the varieties traded under different model specifications. The conducted research confirmed the negative impact of distance on the Extensive margin on the world scale.