PUBLICATIONS & REPORTS

Contents Introduction

This paper investigates how rules of origin imposed on a vertically integrated multinational firm’s subsidiary affect output and welfare under a Cournot competition. Two types of rules are investigated: one requiring the multinational firm’s subsidiary a minimum ratio of expenditures on its domestic intermediate inputs to those on its total intermediate inputs, and the other requiring a minimum ratio of the subsidiary’s expenditures on domestic components to its total revenue. It is shown that both types of rules lead the multinational firm to shift their component factories from the source country to the host country. However, they may have the opposite effects on output of the final good. Furthermore, when the domestic firm has higher marginal cost than the multinational firm’s subsidiary, the second type of rule of origin can increase both domestic and foreign welfare.