Derived Demand

In economics, derived demand (DD) is the demand for an item or service derived from the demand for another or related good or service.

It is a demand for a physical or intangible item for which there is a market for associated commodities and services. DD can significantly influence the market price of the derived product.

Demand generated for anything else is referred to as DD. As a result, machinery demand is derived from consumer items that the machinery can produce.

When there is a lack of demand for consumer products, there is also a lack of demand for the machinery needed to produce them. For example, spending on new construction projects drives demand for bricks.

Understanding Derived Demand

Derived demand refers to the desire for an item or service based only on its potential to demand or supply another good or service.

Resources required to manufacture a commodity, such as capital, land, labor, and essential raw materials, might generate DD.

In many cases, raw material demand is inextricably linked to the need for goods.

When used to predict the prospective market for items other than the initial commodity requested, demand generated from demand for another product can have a tremendous investing approach.

Furthermore, if activity in one area grows, any sector responsible for the success of the first sector may also benefit.

The DD concepts work in both ways. When the demand for a product falls, the demand for the products needed to make that product falls as well.

Derived Demand Curve

Alfred Marshall created the idea of the DD curve for input. Two presumptions are required to generate it.

1. The production circumstances, the demand curve for the finished goods, and the supply curves for all other production inputs remain unchanged.
2. All other manufacturing inputs and the end goods are always in equilibrium in competitive marketplaces.

Under the given circumstances, what amount, x, of the chosen factor of production would be desired at an arbitrary price, y? The generated demand curve provides an answer.

Marshall's calculated demand curve for the chosen production component is shown graphically as the inverse relationship between x and y, where y = f (x).

The point where this demand curve and the supply curve for the production factor connect determines its equilibrium price and quantity.

Low Elasticity of Derived Demand

Supply constraints are encouraged by low DD elasticity. Lack of a suitable replacement, an inelastic demand for the finished product, and an inelastic supply of other manufacturing components contribute to poor elasticity.

The chosen production element accounts only for a tiny portion of the entire cost of production, a concept known as the "importance of being unimportant."

In his novel, The idea of the elasticity of substitution, John Hicks modified the premise of unchanged production coefficients, which indicates a lack of adequate replacements. 

In other words, the expenditure share of the production element must be low relative to the overall cost of production only when the elasticity of demand for the product exceeds the elasticity of input replacement.

Components of Derived Demand

Raw material, processed materials, and labor are the three primary components of DD. According to economists, the chain of DD is made up of these three elements.

1. Raw Materials:

The fundamental components utilized in creating items are known as raw or "unprocessed" materials. For instance, crude oil is used as a raw ingredient to produce petroleum products like gasoline.

Demand for the final item to be produced directly affects and depends upon the degree of DD for a particular raw material.

For example, there will be a high demand for harvested lumber when there is a high demand for new dwellings. Commodities are typically used to refer to raw resources like wheat and corn.

2. Processed Materials:

Products made from raw materials that have been refined or otherwise put together are known as processed materials. For example, paper, glass, fuel, milled timber, and peanut oil.

3. Labor:

Workers—labor—are necessary for the creation of commodities and the delivery of services. Demand for products and services alone determines how much labor is in need.

Labor is a component of DD because there is no demand for the workforce without the need for the products or services it provides.

The Chain of Derived Demand

The movement of raw and processed materials, labor, and final customers is called the “chain of derived demand.” The required raw ingredients are gathered, processed, and assembled when customers desire a product.

For instance, the demand for fabric is increased by customer demand for apparel. Customers’ needs are satisfied when raw materials like cotton are collected, processed into cloth by ginning, spinning, and weaving, and then stitched into the clothing end-users buy.

Some factors affecting the supply chain and market:

1. The Economic Effects of Derived Demand:

The chain of derived demand can impact local and even global economies, in addition to the industries, employees, and customers directly engaged.

For example, a new local market for shoes, jewelry, and other high-end fashion accessories may result from the personalized garments created by a small local tailor.

On a global scale, a rise in demand for raw goods like cotton, timber, or crude oil may open up huge new markets for trade for nations with an excess of such resources.

2. Pick-and-Shovel Strategy:

Because it invests in the underlying technologies required to provide a thing or service rather than the finished item itself, the pick-and-shovel investment approach uses the DD concepts.

It is a means to invest in a sector without dealing with the dangers associated with the market for the finished good. This tactic is known for the equipment used to mine gold during the 1840s and 1850s California Gold Rush. 

To mine gold, prospectors had to purchase picks and shovels. Although there was no assurance that if a prospector discovered gold, the businesses that supplied picks and shovels made money.

They were consequently regarded as sensible investments at that time. The need for gold contributed significantly to the demand for picks and shovels.

The Computer Marketplace:

The need for computers grows as more companies rely on computer technology and consumers upgrade their computing skills.

As a result, we could observe a generated demand for items like a mouse, displays, external discs, and other computer accessories.

We may also see DD for the raw materials needed to make motherboards, video cards, and other internal computer parts.

1. Special Considerations:

Depending on how widely they are used, some manufacturing materials could not undergo significant modifications in response to changes in demand for a particular product.

For instance, cotton is frequently used to make fabric. However, the popularity of a given design or color of cotton fabric may only last for a season or two before declining. In this case, the demand for cotton may not be significantly affected.

Example: mobile phones and lithium batteries

Lithium consumption has significantly increased as a result of the increase in demand for mobile phones and other portable electronics. Batteries also include lithium.

• P = Price
• Q = Quantity
• S = Supply
• D1 = Demand one
• D2 = Demand two

Greater demand for lithium batteries results from increased demand for mobile phones.

Demand for other parts like glass screens and microchips will rise due to the increase in demand for mobile phones.

Increased mobile phone demand might indirectly increase the demand in retail space (to sell them). In the region where phones are made, there will also be a demand for electricity, transportation, and perhaps food services.

The exception to Derived Demand

A slight change in the demand for raw materials due to changes in the need for finished goods is known as the low elasticity of DD. It pertains to goods created using generally accessible raw materials.

Wool, for instance, is used to create coats. The demand for coats rises in the winter while it declines in the summer. The need for wool will be significantly affected by the seasonal variations in demand.

Researched and authored by JunFeng Zhan | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Economies of Scale
• Gross Domestic Product (GDP)
• Macroeconomics
• Nash Equilibrium
• Opportunity Cost