1. Consider the case of three equidistant cities, two of which are in one country, while the third is in a second country. It is likely that transaction costs are higher between the first two cities and the theird, but the basic formula does not account for this.
2. The simple gravity model assumes that the only difference among cities is their population. In fact, there are other dimensions of variation that a more sophisticated model might take into account. (Ex: differences in climate, household income, local government tax, and spending behaviors)