What Is Demand Destruction?
In economics, demand destruction refers to a permanent or sustained decline in the demand for a certain good in response to persistent high prices or limited supply. Because of persistent high prices, consumers may decide that it is not worth purchasing as much of that good, or seek out alternatives as substitutes.
- Demand destruction occurs when a period of high prices or restricted supply causes consumers to permanently change their behavior.
- This results in a reduction of demand for a good even after the supply of the good goes up and/or its price goes down.
- This phenomenon is most often associated with the demand and prices related to energy commodities such as crude oil or gasoline.
Understanding Demand Destruction
Economists use the term “demand destruction” to describe what happens to the demand for goods when markets that supply those goods change in such a way that the structure of the production processes and patterns of consumption of that good fail to adjust and so cannot be sustained. This has been most often applied to energy commodities and related goods.
For instance, persistently high gasoline prices can lead households to purchase smaller, more gas-efficient cars or switch to electric vehicles. This, in turn, reduces the overall demand for gasoline. Oil producers, responding to higher prices, may ramp up production, increasing the supply of oil and reducing its price over time. However, because of the durable shift to more efficient or electric vehicles, the overall demand for gasoline has been permanently destroyed even during periods of lower prices.
With certain markets, demand destruction may render a particular good obsolete entirely. For example, heating oil from whales was once the primary source of light and heat in many places. As cheaper alternatives from fossil fuels were discovered, the high prices of whale blubber made it less attractive, and demand for it plummeted. New infrastructure ultimately was built up around crude oil, causing the switch in demand to become permanent—despite the fact that whale oil had once been categorized by the U.S. government as an “indispensable” commodity.
Is demand destruction permanent?
In many cases, demand destruction causes permanent changes to the structure of a market, sometimes even rendering that good obsolete. However, in other cases, the reduction in demand may only be temporary. This largely depends on the availability of viable alternatives for consumers to adopt and switch to during the period of demand destruction.
Does inflation lead to demand destruction?
High prices can spur demand destruction, especially in energy markets, but only if it induces consumers to change their behaviors in a somewhat durable way. When inflation occurs, prices tend to rise generically across all sectors of the economy. As a result, higher gas prices may also be met with higher vehicle prices, higher food prices, and higher housing costs. In such a case, demand destruction is less likely since all alternatives become more expensive at the same time.
At what price per barrel of oil does demand destruction occur?
This is a question frequently asked by economists and financial analysts. In 2021, Morgan Stanley posted that $80 per barrel would cause demand destruction, but with prices exceeding $100 in 2022, they admit that they were wrong. As the COVID-19 pandemic recedes, people are eager to drive and fly more, and car prices are at all-time highs at the same time, making the switch to more efficient or electric vehicles less tenable. As a result, the critical price for oil may be quite a bit higher than $100 given current economic conditions.