The term “derived demand” refers to the demand for a good or service that itself arises out of the demand for a related or intermediate good or service. Thus the dependent demand often has a notable effect on the market price of the derived good.
It’s important to note the difference between regular demand and derived demand. Regular demand is much more straightforward–it’s just the amount of a good or service that customers are willing to buy at a given moment.
Components of Derived Demand
As a concept, derived demand incorporates three key components: raw materials, processed materials, and labor. These three components form the chain.
Raw materials are those primary, unprocessed products used for the production of goods. They may also be referred to as “commodities.” For example, unprocessed wool is a type of raw material.
Processed materials are those that have taken the raw materials and created new goods using them. For instance, in the case of unprocessed wool, it becomes a processed material when it is cleaned, dyed, and made into yarn.
Labor is the work done by workers either to create goods or to offer services. Labor is a component of derived demand because the demand for labor varies based on the demand for the goods or services that labor produces.
Examples of Derived Demand
For example, the demand for electric guitars creates a derived demand for amplifiers and guitar picks, since you’ll probably need both to play your guitar once you purchase it. It will also create some demand for guitar lessons, for those who purchase their guitar and then need to learn to play it.
Another example might be that of transport. People typically take buses or other public transport in order to get to their place of employment. This means that demand for these types of functional transportation is dependent on the demand for those services provided by the workers using this transportation. It’s easy to see how the ripple effect of the chain of derived demand can be extremely complex and wide-ranging.
Here’s another example. In the case of custom-made bookshelves (for instance), the first step is the raw materials: wood harvested from a forest, for instance, the demand for which was created by the customer’s demand for a wooden bookshelf. Then there are the processed materials: the wood is processed and ready to be used to build a shelf. Finally, there’s the labor: labor goes into using the processed wood to build the shelf, which is finally ready to go to the consumer.
The Economic Effects of Derived Demand
The chain of derived demand has an enormous effect on economies on small as well as large scales. On a national or international scale, greater demand for raw materials may lead to the creation of new trading markets in countries that have those raw materials among their natural resources.