When the demand for a resource or intermediate good is a result of the demand for the final good or service
In economics, derived demand happens when the demand for a resource or intermediate good is a result of the demand for the final good or service. It was first introduced by Alfred Marshall in 1890 in his book, “Principles of Economics.”
The market price of the derived product can be significantly impacted by the derived demand.
Derived demand comprises three components – raw materials, processed materials, and labor. The three elements are called the chain of derived demand.
They are resources that are used in the production of a product. For example, lithium batteries are raw materials for cell phones. The level of demand for lithium batteries is directly related to the level of demand for cell phones (final product).
They are products that have been built from assembling raw materials; steel, gas, and paper are examples of processed materials.
Labor consists of the workers who facilitate the production of goods and the provision of services. The demand for labor depends on the demand for the final good or service – there is no demand for labor when there is no demand for the final product. Labor is a component of derived demand.
The chain of derived demand is the flow of raw materials to processed goods to finished products with the help of labor. An increase in the demand for the end goods by the customer will trickle down to the beginning of the chain.
For example, an increase in demand for stainless steel utensils will increase the demand for steel (processed goods), and in turn, increase the demand for iron ore (raw material).
The chain of derived demand will result in a ripple effect on a local and national level. On the local level, custom two-piece jackets sewn by local tailors will increase the demand of the local market for high-end fashion goods.
On the other hand, higher demand for raw materials will lead to the creation of international trade for those raw materials.
There are two types of derived demands – direct and indirect.
The concept of the derived demand curve can be constructed under two assumptions:
From the derived demand curve, a reader can understand the change in price and the quantity of raw materials due to a change in the demand for the final product. Therefore, the function of derived demand is the inverse of y = f(x). A graphical representation of the derived demand curve can be seen below:
Where:
Low elasticity of derived demand is when the demand for raw material does not change significantly with the change in demand for the final product. It applies to products that are made from widely available raw materials.
For example, wool is used to make jackets. During winter, the demand for jackets increases, but during the summer, the demand falls. The seasonal fluctuation in demand is not going to result in a major impact on the overall demand for wool.
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