What Is Derived Demand?
Let me explain derived demand to you directly: in economics, it's the demand for a good or service that comes about because of the demand for something else related to it. You're looking at a situation where there's a market for both the items in question, and this derived demand can really shake up the market price of the derived product.
Key Takeaways
I want you to grasp this: derived demand is purely an economic term for demand on a good or service driven by demand for another related one. It's all about how that product or service helps in getting or making something else. You can use this concept as a smart investing strategy to predict markets for goods beyond the original one you're eyeing. Think of the pick-and-shovel strategy—it's about investing in the tools needed for a booming product. But remember, if a final product's demand changes, widely used materials might not feel much of a shift.
Understanding Derived Demand
Derived demand ties directly to how a good or service enables you to acquire or produce another one. It gets triggered by what's needed to finish making a particular good, like capital, land, labor, and raw materials. So, the demand for those raw materials is locked to the demand for the products that use them.
Using derived demand from another product can be a solid way to invest, anticipating markets for related goods. If one sector ramps up, the sectors supporting it might gain too.
Here's an important point: this works both ways. If demand for a product drops, so does the demand for what's needed to make it.
Examples of Derived Demand
Take the pick-and-shovel strategy as an example. It applies derived demand by investing in the tech or tools required to produce a good, not the good itself. This avoids risks tied to the end product's market. The name comes from the California Gold Rush in the 1840s and 1850s, where prospectors bought picks and shovels to mine gold. Even if they didn't strike gold, the sellers of those tools made money because the demand for them derived from gold demand.
Another example is the computer marketplace. As businesses and homes rely more on computers, demand for them grows, leading to derived demand for peripherals like mice, monitors, and external drives. This extends to internal parts like motherboards and video cards, plus the materials to make them.
Keep this in mind: even pick-and-shovel strategies have risks; you could still lose if the investment falters despite high derived demand.
Special Considerations
Some production materials won't see big changes from demand shifts in a specific product, especially if they're used widely. For instance, cotton for fabric—if one print or color fades in popularity over seasons, it probably won't dent overall cotton demand much.
How Is Derived Demand Determined?
Derived demand happens when demand for one good or service creates demand for a related one. If demand for the first increases, so does the second, and the same if it decreases.
Why Is Derived Demand Significant?
It matters because demand for one thing affects related goods, services, and their production elements like raw materials, labor, tech, and processed materials. Rising demand can boost international trade and energy needs indirectly. Companies can plan ahead for these shifts based on changes in related products.
What Is Derived vs. Direct Demand?
Direct demand is for a final product or service on its own, not influenced by others. Derived demand, however, depends on demand for another product or service.
What Are the Main Components of Derived Demand?
The key parts are labor, raw materials, and processed materials. Labor is the workforce producing final goods. Raw materials are resources for manufacturing, and processed materials come from combining raw ones with labor. When derived demand changes, demand for these follows suit.
The Bottom Line
To wrap this up, derived demand is when demand for one good affects a related one, involving raw materials, processed goods, and labor. It can sway demand for components, production tech, and market prices. But shifts might not hit widely used materials hard. For you as an investor, watching final product demand helps predict opportunities in related areas—it's a practical strategy.
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