What is derived demand?
Derived demand is an economic term describing the demand for a good / service resulting from the demand for an intermediate or related good / service. It is a demand for something physical or intangible where a market exists for the related goods and services in question. Derivative demand can have a significant impact on the market price of the derivative product.
Key points to remember
- Derived demand is an economic term describing the demand for a good / service resulting from the demand for an intermediate or related good / service.
- Derived demand is only linked to demand placed on a good or service for its capacity to acquire or produce another good or service.
- The principles behind derivative demand work both ways; if the demand for a good decreases, the demand for the goods necessary for the production of the article will also decrease.
Understanding derivative demand
Derived demand is only linked to demand placed on a good or service for its capacity to acquire or produce another good or service. In addition, derived demand can be stimulated by what is necessary to complete the production of a particular good, including capital, land, labor and the necessary raw materials. In these cases, the demand for raw materials is directly linked to the demand for products that require the production of raw materials.
Demand derived from the demand for another good can be an excellent investment strategy when used to anticipate the desire for goods outside the specific good desired. If activity in a sector increases, any sector responsible for the success of the first sector may also see gains.
The principles behind derivative demand work both ways. If the demand for a good decreases, the demand for the goods necessary for the production of the article will also decrease.
Examples of derived request
A first example of derived demand was the pick-and-shovel strategy, which was developed in response to the correlation of market forces. During the gold rush, demand for gold prompted prospectors to search for gold. These prospectors needed picks and shovels, and other supplies, to extract gold. Arguably, on average, those who sold supplies to these prospectors fared better during the gold rush than the prospectors. The demand for picks and shovels came, to a large extent, from the demand for gold at the time.
A more modern example exists in the IT market. As more businesses become dependent on technology and households develop their computing capabilities at home, the demand for computers increases. The derived demand can be shown in the fields of computer peripherals, such as mice and computer screens, as well as in the components necessary for the production of computers. Components can include things like motherboards and video cards, as well as the materials used to produce them.
Some production materials may not undergo large-scale changes based on increases or decreases in demand for a specific product depending on how the production materials are used. For example, cotton is a material widely used in fabric. If a particular print or color is popular in a specific season and the popularity of the print or color decreases in a few seasons, this may not have a significant impact on overall cotton demand .