What is 'Derived Demand'

Derived demand is a term used in economic analysis that describes the demand placed on one good or service as a result of changes in the price for some other related good or service. It is a demand for some physical or intangible thing where a market exists for both related goods and services in question. The derived demand can have a significant impact on the derived good's market price.

BREAKING DOWN 'Derived Demand'

Derived demand is solely related to the demand placed on a good or service for its ability to acquire or produce another good or service. Additionally, derived demand can be spurred by what is required to complete the production of a particular good, including the capital, land, labor and raw materials required. In these instances, the demand for a raw material is directly tied to the demand for products that require the raw material to be produced.

Derived Demand and Investing

The demand that is derived from the demand from another good can be an excellent investing strategy when used to anticipate the desire for goods outside of the specific good desired. If activity in one sector increases, any sector responsible for the first sector’s success may also see gains.

The principles behind derived demand work in both directions. If the demand for a good decreases, the demand for the goods required to produce the item will also decrease.

Examples of Derived Demand

An early example of derived demand was the pick and shovel strategy, which was developed in response to correlating market forces. During the gold rush, the demand for gold prompted prospectors to search for gold. These prospectors needed picks and shovels, as well as other supplies, to mine for gold. It is arguable that, on average, those who were in the business of selling supplies to these prospectors fared better during the gold rush than the prospectors did. The demand for picks and shovels was derived, to a large degree, from the demand for gold at that time.

A more modern example exists within the computer marketplace. As more business became dependent on technology and households expand home computing capabilities, the demand for computers rises. Derived demand may be shown in the areas of computer peripherals, such as computer mice and monitors, as well as in the components required to produce the computers. The components can include items such as motherboards and video cards, as well as the materials used to produce them.

Production Materials

Certain production materials may not experience large-scale changes based on increases or decreases in demand for a specific product depending on how widely the production materials are used. For example, cotton is a widely used material in fabric. If a particular print or color is popular during a specific season and the popularity for the print or color diminishes over the course of a few seasons, this may not have a large impact on the demand for cotton in general.

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