The name is absent

content⁴; (ii) a pre-specific change in tariff heading; (iii) a specific phase of the production
process performed within the preferential agreement; (iv) substantial transformation of name and
characteristics. Thus, the rules of origin implemented in practice may severely constrain the
profit maximization choices of firms. The production choices available to an economy with the
less restrictive Assumption 2 rules of origin imposed are equivalent to the original production set
with pre-FTA opportunities preserved. More restrictive rules, such as those that require more
than a specified fraction of value to be added by the exporting country, fail to preserve initial
opportunities and may reduce the effective production set.

Let superscripts 0 and 1 describe the pre- and post-FTA situations, respectively. Assume
that each household j of country i has preferences that can be represented by a utility function
uj. Consistent with the proof of existence of equilibrium, the income of consumers can be any
continuous function of prices. Here we assume that a particular fair sharing distribution rule is
used, meaning that it provides consumers with enough income to purchase their pre-agreement
consumption bundle at post agreement prices, plus a non-negative supplement:

e^l_j∖pⁱfuj¹] ≡ p¹ ■ x^lf + θ^l_j ((p¹ ■ (yⁱ¹ + T¹ ) - p¹ ■ (yⁱ⁰ + ^ⁱ’⁰))

where ej∖p^z,1,uj^,1 ] is the consumer’s expenditure function, θj f 0, and ^_j. θj = 1.⁵ A fair
sharing distribution rule was used in Grinols (1981), for example, and Grandmont and McFadden
(1972) to prove the existence of competitive equilibrium of Kemp-Wan customs unions and of
Pareto-improving free trade allocations, respectively.

Proposition 2 The fair sharing distribution rule is viable in equilibrium under Assumptions 1
and 2 with transfers across member countries.

Proof. Write the change in welfare for consumer j of member country i = {H,F} under
the distribution rule as AWj ≡ ej∖p¹,uj^,1] — ej∖p¹,uj^,0], where uj’⁰ and uj’¹ represent pre- and
post-FTA utility levels. Then

∑∑ Δ^ = ∑(∑(_pM⁰-4 ⅛¹.⅛°)))             Terml

i j                 i ∖ j                             )

+ ∑ ∣ ∑ ^θ^j P¹ ■ {yⁱ¹ — yⁱ° J                   Term 2

ⁱ ∖ ^j /

+ ∑ I ∑ ^θj P¹ ■ (fⁱ>¹ — ^zi,0 I                Term 3     (2)

ⁱ ∖ ^j /

⁴Krueger (1997).

⁵The sum over j of the right hand side of (2) adds to country i income, p¹ ■ (y^t,1 + ω + z^t,1).

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