Using the gravity equation to differentiate among alternative theories of trade

The simple gravity equation explains a great deal about the data on bilater al trade flows and is consistent with several theoretical models of trade. We argue that alternative theories nevertheless predict subtle differences in key parameter values, depending on whether goods are homogeneous or diff erentiated and whether or not there are barriers to entry. Our empirical wo rk far differentiated goods delivers results consistent with the theoretica l predictions of the monopolistic-competition model, or a reciprocal-dumpin g model with free entry. Homogeneous goods are described by a model with na tional (Armington) product differentiation or by a reciprocal-dumping model with barriers to entry.