Derived Demand

Derived demand refers to the demand for specific products or services that emerge when the demand for other products and services related to them increases. In simple words, when the demand for output rises, a corresponding demand for its input or factor of production increases.

Knowledge of this phenomenon helps investors achieve their business goals by developing effective investment strategies. One such example is the pick and shovel investment strategy. This approach is termed after the California Gold Rush, which occurred in the 19th century when firms supplying picks and shovels were deemed smart businesses since the need for this equipment was spurred by the want for gold.

• Derived demand for an item occurs whenever there is a rise in demand for the items related to them.
• Knowledge of induced demand helps businesses develop investment strategies to utilize the market for input products.
• It can have profound effects on the economies of the nations involved.
• The derived demand curve illustrates the shift in the demand curve and the corresponding change in the demand curve of a related or input product. 

Derived demand is natural in most markets and economies. Such demand usually does not come from consumers but other products, services, or the makers of the consumer products and services. A chain of induced demand will originate as the raw materials get converted into the final product. It is generally associated with resources that take the form of raw materials, semi-finished products, labor, and energy. It is evident in the financial market where a derivative price relies on the underlying asset's value.

Academics often segregate it into direct or indirect categories.

• Directly derived demand: Indicates the demand for primary raw materials required to produce the final product in demand. For instance, the demand for sanitizers induces raw materials like rubbing alcohol or isopropyl alcohol.
• Indirectly derived demand: This one goes beyond just the raw materials. Suppose there is an increase in demand for a product. In that case, it may indirectly affect complementary factors, for instance, the need for more inventory space to store the additional output or increased energy requirement from the production facility.

The phenomenon can also be illustrated and better understood through the derived demand curve. Alfred Marshall developed the concept in his book Principles of Economics. The graph explains how a shift in the demand curve towards the right due to increased demand creates an additional demand for the underlying natural resources needed to make the final product. The first part depicts the increase in demand for product A, and the other part shows the corresponding shift in the demand curve of its input, product M.

The examples of derived demand are observable all around us, even in typical day-to-day life. Here are a few examples for better understanding.

Electric Vehicles

Electric vehicles have increased in demand significantly in recent years. As electric car makers expand into new markets, it has ripple effects on the different economies involved. According to the International Energy Agency, electric vehicle sales will reach 23 million in 2030. With this rise in demand comes the demand for the raw materials needed to make electric vehicles and the various battery components required. Also, the indirect effect reflects in demand for certain things like premises for manufacturing facilities, energy requirements for production, and warehousing and distribution services.

The examples of critical resources whose demand is predicted to increase are Nickel, Cobalt, Iron, and Lithium. The need for these metals will positively impact economies with large amounts of these resources. For example, Chile has the largest lithium reserves in the world. These large reserves can give Chile an advantage as the demand for electric vehicles increases, so will the need for lithium.

New Homes

Another significant example is associated with the housing market. Primarily, the demand for residential land evolved from the need for new homes. However, it also increases building materials like wood, steel, glass, etc. Moreover, as the natural resources grow in demand, labor requirements to construct these homes increase, and the need for additional real estate agents to sell the homes emerges.

Derived demand, both direct and indirect, generally originating from the producer or manufacturer side, has a significant impact on the economy in many aspects. Moreover, it benefits all parties engaged by strengthening the economy and fostering mutually beneficial connections.

This has been a guide to what is a derived demand & its definition. Here we discuss types of derived demand and how it works along with examples and curves. You may also have a look at the following articles to learn more –

• Elastic Demand
• Determinants of Demand
• Non-Price Determinants of Demand