Final answer:
In the Brander-Spencer model, the subsidy raises profits by more than the subsidy due to its deterrent effect on foreign competition. The concept is akin to the multiplier effect in fiscal policy, where an initial outlay has magnified effects on output and income.
Step-by-step explanation:
In the Brander-Spencer model, the subsidy raises profits by more than the amount of the subsidy itself due to the deterrent effect of the subsidy on foreign competition. This deterrent effect means that the subsidy acts as a strategic tool by enabling the domestic firm to commit to a certain level of output that potentially deters foreign competitors from entering the market or expanding production, thus securing a larger market share for the subsidized firm and increasing its profits.
The reason behind this goes beyond the immediate fiscal impact of a subsidy, touching upon the dynamic nature of international markets and strategic trade policies. The multiplier effect in an expenditure-output model similarly shows how an initial increase in expenditure leads to a larger increase in equilibrium output, as one person's spending becomes another person's income. Although this concept mainly applies to fiscal policy effectiveness, the underlying mechanism of initial outlays having magnified effects is relevant in the context of subsidies in strategic trade theory as well.