Derived demand is a term in economics that describes the demand for a certain good or service resulting from a demand for related, necessary goods or services. For example, the demand for large-screen televisions creates a derived demand for home theater products such as audio speakers, amplifiers, and installation services.
Key Takeaways: Derived Demand
- Derived demand is a market demand for a good or service that results from a demand for a related good or service.
- Derived demand has three distinct components: raw materials, processed materials, and labor.
- Together, these three components create the chain of derived demand.
Derived demand exists only when a separate market exists for both related goods or services involved. A product or service's level of derived demand has a significant impact on the market price of that product or service.
Derived demand differs from regular demand, which is simply the quantity of a certain good or service that consumers are willing to buy at a given price at a certain point in time. Under the theory of regular demand, a product's price is based on “whatever the market-meaning consumers-will bear.”
Components of Derived Demand
Derived demand can be broken down into three main elements: raw materials, processed materials, and labor. These three components create what economists call the chain of derived demand.
Raw or “unprocessed” materials are the elemental products used in the production of goods. For example, crude oil is a raw material in the production of petroleum products, such as gasoline. The level of derived demand for a certain raw material is directly related to and dependent on the level of demand for the final good to be produced. For example, when the demand for new homes is high, the demand for harvested lumber will be high. Raw materials, like wheat and corn or often called commodities.
Processed materials are goods that have been refined or otherwise assembled from raw materials. Paper, glass, gasoline, milled lumber, and peanut oil are some examples of processed materials.
The production of goods and the provision of services requires workers-labor. The level of demand for labor depends solely on the level of demand for goods and services. Since there is no demand for a workforce without a demand for the goods it produces or the services they provide, labor is a component of derived demand.
The Chain of Derived Demand
The chain of derived demand refers to the flow of raw materials to processed materials to labor to end consumers. When consumers show a demand for a good, the necessary raw materials are harvested, processed, and assembled. For example, consumer demand for clothing creates a demand for fabric. To meet this demand, a raw material like cotton is harvested, then turned into processed materials by ginning, spinning, and weaving into cloth, and finally sewn into the garments purchased by the end consumers.
Examples of Derived Demand
The theory of derived demand is as old as commerce itself. An early example was the “pick and shovel” strategy during the California Gold Rush. When news of gold at Sutter's Mill spread, prospectors rushed to the area. However, to get the gold from the ground, the prospectors needed picks, shovels, gold pans, and dozens of other supplies. Many historians of the era argue that the entrepreneurs who sold supplies to the prospectors saw more profits from the gold rush than the average prospectors themselves. The sudden demand for the common processed materials-picks and shovels-was derived from the sudden demand for the rare raw material-gold.
In a far more modern example, the demand for smartphones and similar devices has created a tremendous derived demand for lithium-ion batteries. In addition, the demand for smartphones creates a demand for other needed components like touch-sensitive glass screens, microchips, and circuit boards, as well as raw materials like gold and copper need to make those chips and circuit boards.
Examples of derived demand for labor can be seen everywhere. The amazing demand for gourmet brewed coffee leads to an equally-amazing demand for gourmet coffee brewers and servers called baristas. Conversely, as the U.S. demand for coal used to generate electricity has declined, the demand for coal miners has fallen.
The Economic Effects of Derived Demand
Far beyond the industries, workers, and consumers directly involved, the chain of derived demand can have a ripple effect on local and even national economies. For example, custom clothing sewn by small local tailor may create a new local market for shoes, jewelry, and other high-end fashion accessories.
On the national level, an increase in demand for raw materials like crude oil, lumber, or cotton, can create vast new international demand trading markets for countries that enjoy an abundance of those materials.
- “Derived Demand.” Investopedia (June 2018).
- Pettinger, Tejvan. Derived Demand. Economics Help (2017).
- Zack. When There's A Gold Rush Sell Picks and Shovels Hatch (2016).