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example do the gravity model

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economic growth in every country and international economic arena. Therefore, this term paper is based on the econometrics theory to make analysis of multiple regression models on the relationship between Gravity Model of trade variables and volume of trade in between Malaysia and Singapore by using the annual data from year 1979 to 2008. Also, we have used the volume of trade as the explained variable to measure the economic growth, since majority of the countries in nowadays are using the Gravity Model to estimate their countries economic growth. By using the econometrics estimation methods, we can conclude that trade value, GDP of Malaysia, GDP of Singapore, and population between two countries played the significant role and also have the positive effect on the volume of trade. Port distance between Malaysia and Singapore also has played an important role in measuring volume of trade, but it has a negative effect on value of trade. 1.0 Statement of the Problem The model that we have choose to use is Trade = Malaysia GDP + Singapore GDP + Population + Distance. In this model, there are several factors that can affect the trade of a country. Those factors are Malaysia GDP, Singapore GDP, population, and distance. Even that the total amount of distance are consider to be the main factors in affect the trade, however the other factors also can affect the value of trade. First of all, the consumption has played a significant role in the economic growth because the Keynesian theory of consumption showed that the consumption can promote the production of a country. Besides that, Adam Smith also shows that the investment can motivate of the economic growth when in the early period of classical economics. This resulted that the investment also should be considered into the model. Keynesian multiplier theory also said that the governments spending can increase the national income, so this variable also should be taken into the factors in this model. Therefore Malaysia GDP, Singapore GDP, population, and distance should be added into this model. Here we need to find out how those variables can affect the trade in a country. With having this research, we also can find out that which variables will having the most effect in the trade or else all of the variables have the same effect on the trade. When we find out which variables will have more effect on the trade, government can improve in the variable that have more effect on trade. Trade is important because it can show out the economic

growth of a country. With using the trade, we also can compare each countrys economic growth. Besides that, we also can compare a countrys economic growth by compared its each year GDP. All of the economists should be interest in the results. This is because it can help they study of a country when they are doing their researches. Besides that, all of our group members would interest in the results too, because we can do this as a practical before we do other else researches that maybe will include more variables and also more complicated. 2.0 The Review of Literature There are many studies that explore the gravity model of bilateral relation between developing countries such as Celine Carrere (2004), Min Zhou (2010), James E. Anderson (2010), Nuno Carlos Leiton (2010), Joakim Westerlund and Wilhelmsson Fredrik (2006), Carlos Carrillo and Carmen A Li (2002), Hubert P. Janicki, Warin Thierry, and Phanindra V. Wunnava (2005), Suleyman Tulug Ok (2010), Kim-Lan Siah (2009), Giuseppina MariaChiara Talamonand and many other authors. Celine Carrere (2004), using the gravity model for trade agreements and regional expost. The introduction of the correct number of dummy variables that allows to identify of Vinerian the incidence and impact of commercial fraud, while calculating the budget rules observed by the characteristics of pairs of trading partner countries. In previous estimates, the results indicate that regional agreements have resulted in a significant increase in trade between members and are often sacrificed in the world.1 Besides that, Min Zhou (2010) have extended the principle of homophily, the similarity breeds connection is found to have a lot of social networks to learn about global trade. This research also identified geographic and cultural homophily increase in global trade to shows that countries are more profitable they are geographically provide and cultural partners with in global trade. Analysis of other data for bilateral trade in the sector level is to produce an explanation for the observed intensification of geo-cultural homophily. Development of cross-sector trade differences shift the composition of global trade as a whole and make it more susceptible to the influence of geo-cultural. Thus, the two taken

Celine Carrere. (2006). Revisiting the effect of regional trade agreements on trade flows with proper specification of the gravity model, European Economic Review, 50, pp 223-247.

together for global trade becomes more geo-culturally embedded.2 James E. Anderson (2010) has explained the gravity that gravity has long been one of the most successful empirical models in economics. In addition, the basic theory of gravity in the recent practice has resulted in estimated to be richer and more accurate. The interpretation of the spatial relationships is also reflected by gravity. Author also explains about recent developments are reviewed here and recommendations are made to promising research in the future.3 For Nuno Carlos Leiton (2010), the review of factors that determine bilateral trade between the U.S. and NAFTA, EU, and ASEAN countries in the period 1995-2008. Findings indicate that current U.S. trade by the Linder hypothesis, while the bilateral trade relations in connection with the theorem of Heckscher-Ohlin-Samuelson. Results showed that geographic distance is negative and significant, that increased trade if transport costs fall. The authors have introduced the dimension of the economy, productivity, and foreign investors. These results also confirm the hypothesis that foreign direct investment positively correlated in the trade. 4 This paper examines the effects of zero gravity model of trade in the estimation using the two data, simulated and real. The author also shows that the usual methods of estimating the log-linear may lead to the inference of fraud when some observations are zero. As an alternative approach, the author suggests using a fixed effects Poisson estimator. This approach can eliminates the problem of zero, as open trade and perform well in small samples.

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Carlos Carrillo and Carmen A Li (2002) have applies the gravity model to check the effects of the Andean Community and Mercosur in both trades is two intra-regional and intra-industry in the period 1980-1997. After accounting the effects of size and distance, preferential trade agreements of the Andean Community has a significant influence on the two different products and as a reference for certain capital-intensive goods. Meanwhile, the

Min Zhou. (2011). Intensification of geo-cultural homophily in global trade: Evidence from the gravity model, Social Science Research, 40, pp 193-209. 3 James E.Anderson. (2010). The Gravity Model, NBER Working Paper Series. 4 Nuno Carlos Leitao. (2010). The Gravity Model and United States trade, Europe Journal of Economic, Finance and Administrative Sciences, 21, pp 93-100. 5 Joakim Westerlund and Fredick Wilhelmsson. (2006). Estimating the gravity model without gravity using panel data, pp 1-14.

have a

positive

effect on capital

intensive sub-reference product categories.6 Then, Hubert P. Janicki, Warin Thierry, and Phanindra V. Wunnava (2005) are review the empirical evaluation of the theory of endogenous currency area is optimal. Gravity model used to rate the effectiveness of empirically the convergence criteria by reviewing the specific benefits that guides the location of multinational investment in the European Union. A fixed effects model based on panel data of foreign direct investment (FDI) flows in the 15 European Union shows that horizontal investment encourages the diffusion of production processes across national borders. In particular, the Maastricht criteria for convergence of interest rates show the governments fiscal policy and debt played an important role in attracting multinational investment.7 Since the pioneering work of Tinbergen (1962) and Poyhonen (1963), gravity models have become standard tools for studying bilateral trade. The author also suggests some continuation of the standard gravity model. This equation was modified and tested using panel data from 140 observations over the period 2000-2008. This result in a specification which you can be seen (i) income that is more flexible response, (ii) competitive effects of a general and special part, and (iii) an alternative and consistent size of remoteness. These connections are found to be significant factors in explaining intra-EU.

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Kim-Lan Siah (2009) debate about the economic integration of ASEAN and its ability to promote intra-ASEAN, namely Indonesia, Malaysia, Philippines, Singapore and Thailand. To achieve this, the gravity model has been modified to estimate the autoregressive distributed lag (ARDL) framework, or approach to testing the limits for each of the five ASEAN countries. Empirical results showed that the effects of the economic size of bilateral trade flows in both trade-ASEAN trade blocks is increased, depend on the particular country. However, the ASEAN countries may have no overall benefit from the establishment of AFTA as a deflection of trade that may occur in regional market.

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Carlos Carrillo and Carmen A Li. (2002). Trade blocks and the gravity models evidence from Latin American countries, pp 1-30. 7 Hubert P. Janicki, Thierry Warin and Phanindra. (2005). Endogenous OCA theory: using the gravity model to test mundeils intuition, Center For European Studies, 125, pp 1-15. 8 Suleyman Tulug Ok. (2010). What determines intra-EU trade? The gravity model revisited, International Research Journal of Finance and Economic, 39, pp 245-250. 9 Kim-Lan Siah. (2009). AFTA and the intra-trade patterns among ASEAN-5 economies: trade-enchancing or trade-inhibiting?, International Research Journal of Finance and Economi c, 1, 1, pp 117-126.

The author has estimated the factors that affect foreign direct investment flows using gravity equations and the importance of controlling both the traditional gravity variables (size, level of development, distance, common language) and other institutional variables such as shareholder protection (La Porta et al., 1998 and Pagano and Volpin, 2004) and openness to FDI (Shatz, 2000). The purpose of this study was to identify factors that determine the outcome of multinational companies to establish new foreign affiliates abroad.

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Will Martin and Pham Cong (2007) has systematically explains that allows you to see the zero trade flows are very common in international trade. It aims to determine the best approach to estimate the zero-gravity model of trade flows and heteroskedasticity problems highlighted in the paper the influence of Silva and Tenreyro. Based on Monte Carlo simulations with the data constructed using the Tobit-type, we find that the Eaton-Tamura (E-T) Tobit estimator generally has the smallest bias, although not necessarily better than the truncated OLS regression. ET estimator with a strong emphasis on ensuring that the correct error is determined and the lowest bias will be investigated. The Heckman Maximum Likelihood estimators appear to perform better if properly identify the existing restrictions.

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The authors have examines how much the gravity model that explains the various cross-border flows that can lead knowledge spillovers. It turns out that the model works well for trade and telephone traffic, but less satisfactory for the flow of mergers and acquisitions.

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Chan-Hyun Sohn (2005) has applied the gravity model to explain bilateral trade flows of South Korea. A trade structure and trade network in the Asia-Pacific region, including the gravity equation to describe the peculiarities of trade patterns in South Korea. Korea has significant commercial potential that have not been realized with Japan and China, indicating that they are required partners for FTAs. These authors also have applies the extract practical trade policy applications. Empirical results showed that South Koreas trade follow the Heckscher-Ohlin model is more of a decision to increased or model of product

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Giuseppina Maria Chiara Talama, Institution FDI and the gravity model, pp 1-41. Will Martin and Cong Pham. (2007). Estimating the gravity model when zero trade flows are important, pp 119 12 Wei-Kang Wong. (2007). Comparing the fit of the gravity model for different cross-border flows, pp 1-11.

differentiation. North-South Korean trade will expand significantly if the normal bilateral relations and North Korea will participate in APEC.

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Jacques Melitz (2006) generally assumed that distance in the gravity model strictly reflects frictions that hinder bilateral trade. However, distance North-South could also reflect differences in factor endowment, which provides opportunities for a profitable trading. In addition, significance of North-South differences that survive the stress test, the period, the difference of latitude North-North, North-South and South-South, and the other control s the size difference in the timeless factors, such as differences in output per capita and the average temperature difference average, rainfall, and seasonal temperature range. Finally, the study of the impact of internal distance and remoteness made the trade because the two variables specific to a particular country. This is done by studying its effect on the country fixed effect themselves have previously estimated. Internal distance it possessed a much greater effect than isolation.14 The authors have implemented the gravity model on panel consisting of India with annual bilateral trade with all trading partner in the second half of the twentieth century. The main conclusion that emerges from this analysis are: (1) the core gravity model can explain about 43 percent of volatile trading in India for centuries in the second half of the twentieth century, (2) trade between India and less than proportionate response to the size and more than proportionately the distance, (3) colonial herigate is still an important factor in determining the direction of trade between India and at least in the second half of the twentieth century, (4) India trade and more advanced than backward countries, but (5) determine the size of a influence on the development of trade between India and trade partners.

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I-Hui Cheng and Howard J. Wall (2005) was compare the various specifications of the gravity model of trade as nested versions of a general specification of bilateral countrypairs with fixed effects to control heterogeneity. For each specification, the authors also show that the theoretical restrictions used to obtain them from the general model is not supported by the statistics because of the gravity model has become the workhorse baseline model to estimate the effects of international integration. It is important for the

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Chan-Hyun Sohn. (2005). Does the gravity model explain South Koreas trade flows?, The Japanese Economic Review, 56, 4, pp 417-430. 14 Jacques Melitz. (2007). North, South and distance in the gravity model, European Economic Review, 51, pp 971-991. 15 Ranajoy Bhattacharyya and Tathagata Banerjee. (2006). Does the gravity model explain Indias direction of trade? A panel data approach, Research and Publications, pp 1-18.

empirical implications. In particular, the author shows that, unless heterogeneity is properly recorded the gravity model may overstate the impact of integration on trade volumes.

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Amita Batra (2004) has used the gravity model has been enhanced in advance to analyze the flow of world trade and the coefficients obtained are then used to predict trade potential for India. The dependent variable in all tests performed were total merchandise trade (exports plus imports in U.S. dollars), in log form, between pairs of countries. Results show that the authors estimate the gravity equation fits the data and provide timely and accurate revenue and elasticity sense of distance and estimates for others, such as geographic, cultural characteristics and history. Alternative size of GNP in current dollar value and purchasing power parity is not changes either the sign or significance of different explanatory variables. The highest amount of potential trade between India and the AsiaPacific region, follow by Western Europe and North America. Countries like China, UK, Italy, and France only disclose the maximum potential for expanding trade with India.17 Konstantinos Kepaptsoglou, Matthew G. Karlaftis and Tsamboulas Dimitrios (2010)

mentions gravity model has been widely used in the study of international trade over the last 40 years as strength and endurance quite empirically clear. Gravity model used to assess the implications for policy and trade, especially recently, to analyze the impact of Free Trade Agreements on international trade. The aim is to review new empirical literature on gravity models, highlight best practices and provide an overview of the impact Free Trade Agreements on international trade.

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According to the authors, Dixit (1989), Eichengreen & Irwin (1996), Anderson & Marcouiller (1999) and Das et. Al. (2001) showed that determine sunk costs in the model of bilateral trade. By using this literature, some economists have introduced the lagged trade variable in the model. However, in determining the commercial model, it is expected that the economic agents expectations are more important than the lagged trade variable. In addition, expectations are likely to be included in a model of bilateral trade by considering the cost of risk. In this paper, the authors develop a model of Anderson and Wincoop (2003) for the theoretical gravity model that takes into account the costs of trade are expected to determine the volume of bilateral trade. Enable the development of new theories in the

16

I-Hui Cheng and Howard J. Wall. (2005). Controlling for Heterogeneity in gravity models of trade and integration, pp 49-64. 17 Amita Batra. (2004). Indias global trade potential: the gravity model approach, pp 1 -43. 18 Konstantinos Kepaptsoglou, Matthew G. Karlaftis and Dimitrios Tsamboulas. (2010). The gravity model specification for modeling international trade flows and free trade agreement effects: a 10-year review of empirical studies, The Open Economics Journal, 3, pp 1-13.

hope of determining the commercial model. Authors also suggest methods for estimating the future growth of bilateral trade costs. In addition, theoretical models allow authors to justify the existence of several variables that are commonly used in the gravity models. Lack of hope can lead to wrong interpretation of the coefficients of these variables.

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Shaohui Mao and Dr Michael J. Demetsky (2002) examine the application of gravity models for the delivery of the process flow distribution throughout the country according to their commodity. Transport stream output and attraction equations are then developed for the Virginia area. Gravity model has also been implemented in the allocation for primary commodities in this area. Four scenarios commodity flows in the state and national levels that are considered to determine the flow within and between Virginia and outside the region. Friction factors is calculated by regression analysis using logform the gamma function and calibrated with the distribution of the long journey and the root mean squared error method. K-factor is introduced to determine trends and aid in model predictive capability. Transport stream output and attraction equations were applied to the factors of production to estimate the socio-economic attractiveness in the future. Research done by the authors showed that gravity model for predicting the flow of goods in the distribution of goods. This study shows that the gravity model for predict the flow of good in the cargo flow of commodities.20 The author of this article do research aimed at studying the intra-ASEAN trade is created (higher trade with competent members) or transfer dealers (higher trade with members of the incompetent) for both commercial of inter-industry and intra-industry. Since the ASEAN integration efforts should be directed to "open regionalism", the factors that affect trade, both inter-industry trade and intra-industry trade at the sector level have been identified. This research adopts an extended gravity model of total and phase-separated by using a number of the Standard International Trade Classification (SITC) Revision 2. Based on the findings, in general, policies that encourage growth and development in the area must be maintained. In addition, steps should be taken to ensure lower transportation costs include both physical infrastructure and increase the efficiency of the transport system. Emphasis should also be focused on other factors that may affect the demand for

19 20

Javad Abedini. (2005). The gravity model and sunk costs: a theoretical analysis, pp 1-29. Shaohui Mao and Dr. Michael J. Demetsky. (2002). Calibration of the gravity model for truck freight flow distribution, pp 1-61.

exports such as product development to improve the quality of exports to meet the priorities of importing countries.21 Mark N. Harris and Laszlo Matyas (1998) states that the types of gravity model are often used to analyze trade flows between countries and trade blocs. Recently, Gravity model has been adapted to public and panel data settings, where time-series cross section data set was collected. This approach not only increases the degree of freedom, but also enables precise specification of the effects of source and target countries and the effect of time (or the business cycle). In this paper, the authors have reviewed the framework of the union, the latest developments in econometric methodology, Gravity model, and improve the estimation technique to calculate the possible simultaneity bias. Although the equipment is completed determined the impact of the Gravity model has been expected previously, this paper contains the result of the first of his random effects. The author also suggests a connection to the base model, which explains the fact that contemporary trade flows that may be closely related to the previous. Finally, all the various models and methods are illustrated with applications to export flows in the APEC area. The result clearly shows that it is important to determine the correct model, in terms of resources, targets and effects of business cycles. Explanatory variables of interest are found in domestic GDP and the target, and depending on the specifications of the resident, local and domestic exchange rate, foreign currency reserves.

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Ruzita Mohd. Amin, Zarina Hamid and Norma MD Saad. (2009). Economic integration among ASEAN countries: evidence from gravity model, 40, pp1-86. 22 Mark N. Harris and Laszlo Matyas. (1998). The econometries of gravity model, Melbourne Institute Working Paper, 5, 98, pp 1-18.

3.0 3.1

TRADE = f (GDPM, GDPS, POP, DIST) The value of trade between Malaysia and Singapore is determined by GDP of the Malaysia and Singapore, populations of the Malaysia and Singapore and the distance between Malaysia and Singapore is based on a gravity model. The economic model is: TRADE= 1 + 2GDPM + 3GDPS + 4POP+ 5DIST Where TRADE represents the value of trade between Malaysia and Singapore, billion $US, GDPM and GDPS represents the GDP of Malaysia and Singapore, billion $US, POP represents the populations of the country Malaysia and Singapore, million and DIST represents the distance between country Malaysia and Singapore. The symbols are the unknown parameters that describe the dependence of the

value of trade between Malaysia and Singapore on different country of GDP (GDPM and GDPS), populations of the country Malaysia and Singapore and distance between country Malaysia and Singapore. Parameter is the intercept and it is also the value of dependent variable when each of the independent variables takes the value of zero. However, this parameter dont have clear economic interpretation in many case including this case because it is not realistic to have situation where A = E = 0. The signs of parameter can be positive or negative. If an increase in the parameter leads to an increase in the dependent variable, then parameter > 0. Conversely, if an increase in the parameter leads to a decrease in the dependent variable, then parameter < 0.

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The hypothesis that we wish to test is the significance of the GDP of the Malaysia and Singapore, the populations of the Malaysia and Singapore and the distance between Malaysia and Singapore on the value of trade between Malaysia and Singapore, which means to examine the relationship between the GDP of the Malaysia and Singapore, the populations of the Malaysia and Singapore, the distance between Malaysia and Singapore and the value of trade between Malaysia and Singapore. 4.0 4.1 The Econometric Model Econometric Model This model is a log-log model where both dependent and independent variables are transformed by the natural logarithm, the purpose to solve the measurement problem. LNTRADEi represents the value of trade between Malaysia and Singapore in year i, LNGDPMi and LNGDPSi represents the GDP of Malaysia and Singapore in year i, LNPOPi is represents the populations of Malaysia and Singapore in year i, LNDISTi represents the distance between Malaysia and Singapore in year i, and is error term in year i.

Error assumption (e): cost of transportation between Malaysia and Singapore, cost of communications between Malaysia and Singapore, exchange rate between Malaysia and Singapore, total production at Malaysia and Singapore and others. 4.2 The Assumption of This Model, (Hill. R.C et al, 2008: 111) To make the econometric model, assumptions about the probability distribution of the random error ei need to be made. The assumptions that we introduce for ei are similar to those introduced for the simple regression model.

1. LNTRADEi = 1 + 2LNGDPMi + 3LNGDPSi + 4LNPOPi + 5LNDISTi + ei, =1,,30 2. LNTRADEi = 1 + 2LNGDPMi + 3LNGDPSi + 4LNPOPi + 5LNDISTi + ei, the expected

of LNTRADEi depends on the explanatory variables and the unknown parameter. E( ) = 0 3. Var(LNTRADEi) = Var ( ) = . The variance for total output is same with variance of error term. 4. Cov (LNTRADEi, LNTRADEj) = Cov (ei, ej) = 0. The random error (e) and dependent variable ( ) statistically independent, uncorrelated. 5. The variables of each are parameter are not random and are not exact linear functions of the other independent variables.

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In addition to the above assumptions about the error term (and hence about the dependent variable), make two assumptions about the explanatory variables. The first is that the explanatory variables are not random variables. Thus we are assuming that the values of the explanatory variables are known to us prior to observing the values of the dependent variable. This assumption is realistic for trade variables and trade for these variables are set accordingly. For cases in which this assumption is untenable, our analysis will be conditional upon the values of the explanatory variables in our sample, or further assumption must be made. The second assumption is that any one of explanatory variables is not an exact linear function of the others. This assumption is equivalent to assuming that no variable is redundant. As we will see, if this assumption is violated, a condition called exact collinearity, the least squares procedure fails. 5.0 5.1 The Data Data In this term paper, we used the annual data from year 1979 until 2008 of the bilateral trade between Malaysia and Singapore. The annual variables that we used in this term paper are the GDP of the Malaysia and Singapore (Billion USD), the populations of the Malaysia and Singapore (Million), the distance between Malaysia and Singapore and the value of trade between Malaysia and Singapore. 5.2 Data Source The source of the data is from the website. This is from: Trading Economics http://www.tradingeconomics.com/ Department of statistics Singapore http://www.singstat.gov.sg/ Malaysia external trade Development Corporation http://www.matrade.gov.my/cms/content.jsp?id=com.tms.cms.section.Section_7273 81fb-7f000010-562d562d-dcfd3067 .

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6.0 6.1

The Estimate and Inference Procedures Estimation Method In this term paper, we used the Least Squares Estimation method to examine the

data to know relationship the variable in this model. Panel data allow estimating a timevarying elasticity of trade with respect to distance as dummy variable. 6.2 Reason for Choosing Least Squares Method There are several reasons for choosing this method. The first reason is because this method can help us to find out the parameter estimates are in the coefficient column, the symbol of C represents constant term (the estimate b1), the estimate b2 is Malaysia GDP, the estimate b3 is Singapore GDP, the estimate b4 is population Malaysia and Singapore, and the estimate b5 is distance between Malaysia and Singapore. The second reason is because we can find out the standard error, t-statistic, and probability for each parameter. Standard errors are used in hypothesis testing and confidence intervals. Besides, we use the value of t-statistic to decide either to reject the null hypothesis or not to reject it. In addition, the pvalue, or known as probability value of the outcome can help us to determine the outcome of the test by comparing the p-value to the chosen level of significance (), without looking up or calculating the critical values. Through this Least Square method, it provides the coefficient of determination, or adjusted , which is the fraction of the sample variance of Yi explained by the regressors. 23 Another reason to choose this method is to obtain the , which is an alternative for measure the goodness-of-fit. In addition, the adjusted R2 is a modified version of the R2 that does not necessarily increase when a new regressor is added.24 Besides, the reason for using Least Square method is to estimate the sum of squared least squares residuals, reported as, sum square resids, which is used to explain the part of total variation in y about its mean that is not explained by the regression. The last reason to choose the Least Squares method is to find out the F-statistic to test the overall significance of a model.

23

James H. Stock, Mark W. Watson. (2007). New York: PearsonEducation, Introduction To Econometrics, Second Edition, Inc, pg 200. 24 Ibid., pg 201.

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6.3

Hypothesis Testing Procedures Hypothesis testing, which is the foundation for all inference variables in classical

econometrics.25 Overall, we will use the t-test, p-value, interval estimation, and F-test to test the significance of the model. First, we use t-test to estimate the value for test statistic which will be used to decide whether to reject the null hypothesis or not to reject it. It has a special feature where the probability distribution is completely know when the null hypothesis is true, and it has some other distribution if the null hypothesis is not true. Besides, we can also use the p-value in the hypothesis testing. P-value, or also known as probability value, is used to determine the outcome by comparing it to the chosen level of significance, , whether to reject or not reject the null hypothesis. It is the quickest way to find out the hypothesis test by comparing the p-value without looking up or calculating the critical value. The interval estimation is used to estimate the range of the outcome. F-test has the same function with t-test, but it has being distinguished by test the joint null hypothesis. LNTRADE= 1 + 2LNGDPM + 3LNGDPS + 4LNPOP+ 5LNDIST + e 6.3.1 T-test Procedures

Testing of Malaysia GDP. 1. The null and alternative hypothesis is H0: 2 = 0 and H1: 2 0. 2. The test statistic, if the null hypothesis is true, is t = b2/se(b2) ~ t(N-K) 3. Using a 5% significance level ( = 0.05), and noting that they are 25 degrees of freedom, the critical values that lead to a probability of 0.025 in each tails of the distribution are t(0.975,

25)

25)

hypothesis if the calculated value of t from step 2 is such that t 2.059 or t -2.059. If -2.064 t < 2.064, we do not reject H0. It is the same procedures to test the LNGDPS, LNPOP, and LNDIST by substituted the null hypothesis and alternatives hypothesis as following: LNGDPS LNPOP LNDIST H0: 3 = 0 and H1: 3 0 H0: 4 = 0 and H1: 4 0 H0: 5 = 0 and H1: 5 0

25

Russell Davidson, James G. MacKinnon (2004). New York: Oxford University, Econometric Theory and Methods, Press, Inc, pg 177.

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6.3.2

P-Value Procedures

For the p-value for LNGDPM, we reject H0: 2 = 0 if P 0.05. For the p-value for LNGDPS, we reject H0: 3 = 0 if P 0.05. For the p-value for LNPOP, we reject H0: 4 = 0 if P 0.05. For the p-value for LNDIST, we reject H0: 5 = 0 if P 0.05. The p- value is given by: P(t(25)> the value of t-statistic in positive) + P(t(25)< the value of t-statistic in negative) 6.3.3 Interval Estimation Procedures

We are finding a 95% interval estimate for 2, 3, 4, and 5, the response LNTRADE to a change in GDP of Malaysia, GDP of Singapore, population, and distance. Step 1: Find a value from the t(25)-distribution, called tc. P(-tc < t(25) < tc) = 0.95 Step 2: Find the value of tc and rewrite the equation. Step 3: Rearrange the equation. P[b2 tc x se(bk) k b2 + tc x se(bk)] = 0.95 Step four: The interval endpoints. [bk tc x se(bk), bk + tc x se(bk)] 6.3.4 F-test Procedures 1. We want to test H0: 2 = 0, 3 = 0, 4 = 0, 5 = 0 Against the alternative H1: At least one of k is nonzero for k = 2, 3, 4, 5 2. If H0 is true 3. Using a 5% of significance level, we find the critical value for the F- statistic with (4,25) degree of freedom is Fc = 2.76. Thus, we reject H0 if F 2.76.

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7.0 7.1

Dependent Variable: LNTRADE Method: Panel Least Squares Date: 03/06/11 Time: 15:15 Sample: 1979 2008 Periods included: 30 Cross-sections included: 60 Total panel (balanced) observations: 1800 Variable C LNDPM LNDGPS LNPOP LNDIST Coefficient -108.0519 0.050911 0.231105 7.713531 -0.108752 Std. Error 1.714297 0.004747 0.018317 0.112518 0.463132 t-Statistic -63.02985 10.72600 12.61719 68.55378 -0.234819 Prob. 0.0000 0.0000 0.0000 0.0000 0.8144

Effects Specification Cross-section fixed (dummy variables) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) 0.988945 0.988544 4.824032 40398.94 -5354.005 2464.967 0.000000 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat 85.50633 45.06967 6.020005 6.215402 6.092134 2.711914

7.2

EViews regression output. Using the annual data from year 1979 until 2008 between Malaysia and Singapore,

the output from the software package EViews is shown in Figure 7.1. Based on this EViews output, it has shown the parameter estimates or also known as coefficient estimates for each least squares estimators such as b1, b2, b3, b4 ,and b5. b1 = - 108.0519; b2 = 0.050911; b3 = 0.231105; b4 = 7.713531; b5 = -0.108752 LNTRADE = -108.0519 + 0.050911LNGDPM +0.231105 LNDGPS + 7.713531 LNPOP + (0.108752 LNDIST) We measure the fit of the data base on adjusted R2 = 0.9885 where, 98.85 percent changing in trade explain by Malaysia GDP, Singapore GDP, Population and Distance. However 1.15 percent changing in trade explain by other factor.

16

7.3

Interpretation of Coefficient Estimates The coefficient on Malaysia GDP is positive. We estimate that, with Singapore GDP,

population, and distance held constant, an increase in Malaysia GDP by 10 % will lead to an increase in trade of 5%. Or, expressed differently, a decrease in Malaysia GDP of 10% will lead to a decrease in trade of 5%. Besides, the coefficient on Singapore GDP is positive. We estimate that, with Malaysia GDP, population, and distance held constant, an increase in Singapore GDP of 10% will lead to an increase in trade of 2%. Expressed in differently, a reduction in Singapore GDP of 10% will lead to a decrease in trade of 2%. In addition, the coefficient on population is positive. We estimate that, with Malaysia GDP, Singapore GDP, and distance held constant, an increase in population of 1% will lead to an increase in trade of 7.%. Or, expressed in differently, a decrease in population of 1% will lead to a decrease in trade of 7%. However, the coefficient on distance is negative. We estimate that, with Malaysia GDP, Singapore GDP, and population held constant, an increase in distance of 10% will lead to a decrease in trade of 1%. Or, expressed in differently, a decrease in distance of 10% will lead to an increase in trade of 1%. 7.4 The Values of Test Statistic and Statistical Significance Based on the EViews output Figure 7.1. Using the t-test to show the significant of this model and how each variable can influence trade. The value of test statistic for Malaysia GDP is. 10.72600 Refer to the t-test procedures at part (6.3.1). Since t = 10.72600 > 2.059, we reject the null hypothesis that 2 = 0. That is, there has relationship between Malaysia GDP and trade at 5% significant level. On the other hand, the value of test statistic for Singapore GDP is 12.61719. Based on 5% significant level, we reject the null hypothesis that 3 = 0 because t > 2.059. That is, Singapore GDP has relationship to explain changing on trade. Besides, the value of test statistic for population is 68.55378. Since t = 68.55378 > 2.059, we reject the null hypothesis that 4 = 0. In 5% significant level, population can explain why trade change if population also change. The value of test statistic for distance is -0.234819. We do not reject the null hypothesis that 5 = 0. That is, we are not able to conclude distance is full factor why trade 17

is reduce on 5% significant level test where, -0.234819 < -2.059. However, we can conclude that there is a statistically significant negative relationship between distance and trade. 7.5 The P-Value Based on the EViews output, the p-value for Malaysia GDP is 0.0000. Using the pvalue procedures at part (6.3.2), since 0.0000 < 0.05. That is statistically significant and factor on trade changing. Next, the p-value for Singapore GDP is 0.0000, where 0.0000 < 0.05. That means Singapore GDP factor of trade changing. Population is factor on explain why trade is change because the p-value is 0.0000 < 0.05. The p- value for distance is 0.8144 and since p-value > 0.05. Distance is not significant to explain why trade is change but is still influence on changing because today globalizations transport encourage trade in big scale. 7.6 Interval Estimation Based on the procedures for interval estimation in (6.3.3), the interval estimate for Malaysia GDP is (0.041136, 0.060685). That is, we estimate with 95% confidence that an additional 1% of consumption will increase between 0.041136 and 0.060685 on trade. The interval estimate for Singapore GDP is (0.193390, 0.268819). That is, we estimate that the additional 1% of Singapore GDP will increase the trade in between 0.193390 and 0.268819. The interval estimate for population is (6.981856, 7.445205). That is, we estimate that an additional 1% of population will increase between 6.981856 and 7.445205 on trade. The interval estimate for direct is (-1.062340, 0.844836). We estimate that an additional 1% of distance will either decrease the trade until -1.062340 or increase until 0.844836. 7.7 The F-test F-test is used to make sure the significant on this model based on the procedures in (6.3.4), the value of F-test for the model is 2464.967. Since 2464.967 2.76, we reject the H0: 2 = 0, 3 = 0, 4 = 0, 5 = 0, 6 = 0. All variable is factor that influence of trade changing because the model is fit and significant to explain why trade raise and how trade will growing up.

18

7.8

The Relation with Previous Estimate In this term paper, we have examined the relationship of economic growth, or

known as trade, with the trade variables and found out that each of trade variables will affect the economic growth. According to previous estimate, Wong, (2008) examined the importance of exports and domestic demand to economic growth in ASEAN-5, namely Indonesia, Malaysia, the Philippines, Singapore and Thailand before Asia financial crisis, 1997- 1998. It has shown that there is a relationship between export economic growth.26 It is same with our estimate that the trade variables, which are Malaysia GDP, Singapore GDP, population, and distance, are influencing economic growth, or trade. 7.9 Economic Implication The impacts of trade variables are important to the economic growth. The component of trade variables, which are Malaysia GDP, Singapore GDP, population, and distance are vital to stimulate economic growth. In the estimated trade model, Malaysia GDP, Singapore GDP, and population have a positive relationship with the trade. This means that one of the component or the entire component is increase, the trade will increase, or in other word, the economic are growing. While for the distance, it has a negative relationship with the trade. If the distance is increase, it will lead the trade decreased. 8.0 Possible Extensions and Limitations of the Study From the empirical result above, the relationship between gravity model variables has shown strong in determine volume of trade, this is because the R-square value is 0.988945. Even though, the equation still can be expanded for the future research. First of all, Malaysia and Singapore have the highest values of GDP, which measures the total value of all goods and services produced in an economy. There is a strong empirical relationship between the size of countrys economy and the volume of both its import and its export. Besides that, we should not ignore the role of population plays in the gravity model. This is because from the population theory of neo-classical economics involved a series of equations which showed the relationship between labour-time, living standard, poverty rate, and investment which found that the population and the economic growth in the real economic system have causal effect.

26

Omoke Philip Chimobi, Ugwuanyi Charles Uche. (2010). Export, Domestic Demand and Economic Growth in Nigeria: Granger Causality Analysis. European Journal of Social Sciences. Vol. 13. 19

Lastly, the distance between two countries important plays to fit the data on value of trade. There are important if two countries port distance is nearer, so that trade of two countries can reduce their transport fees. 9.0 Conclusion

Through using the t-test, p-value, interval estimation, and F-test on the Malaysias economic annual data, we can conclude that all the gravity model variables have played an important role in measure and also affect on volume trade in Malaysia. In addition, the EViews output has shown the 0.988945 for the R-squared, it means all of those gravity model variables or explained variables are fitted regression equation LNTRADE= 1 + 2LNGDPM + 3LNGDPS + 4LNPOP+ 5LNDIST + e. Besides, we also conclude that, trade value, GDP of Malaysia, GDP of Singapore, population and port distance between Malaysia and Singapore played the significant role and also have the positive effect on the volume of trade. Port distance between Malaysia and Singapore also has played an important role in measuring volume of trade, but it has a constant effect on GDP.

20

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