Definition
Derived demand is demand for an input (a good, service, or factor of production) that exists because there is demand for some other final product. In other words, people or firms want X only because X is required to make or deliver Y. Examples of inputs include labor, raw materials, and processed components.
Why it matters (short)
– Helps firms and suppliers forecast sales and capacity needs.
– Offers investors an indirect way to gain exposure to an industry (by buying the suppliers rather than the final-product firms).
– Moves in either direction: if demand for the final product rises, demand for its inputs usually rises; if final-product demand falls, input demand tends to fall.
Key components
– Labor: workers needed to produce the final good or service.
– Raw materials: primary resources (ore, cotton, oil) used to manufacture.
– Processed materials/components: parts produced from raw inputs (steel plates, memory chips).
Derived versus direct demand
– Direct demand: desire for the final good or service itself (e.g., consumers wanting smartphones).
– Derived demand: demand for something used to produce that final good (e.g., demand for smartphone chips, assembly labor).
How derived demand is estimated (simple formula)
Derived input demand ≈ Final-product demand × Input required per unit.
Assumptions: constant input-per-unit intensity, no substitution, and no immediate supply constraints. Real-world use requires adjustments for productivity changes, recycling, and substitution.
Worked numeric example
Scenario: A carmaker expects to sell 10,000 additional cars next year. Each car requires 1,200 kilograms of steel.
Step 1 — Multiply:
Extra steel needed = 10,000 cars × 1,200 kg/car = 12,000,000 kg.
Step 2 — Convert to metric tons (1 metric ton = 1,000 kg):
12,000,000 kg ÷ 1,000 = 12,000 metric tons.
Interpretation: The carmaker’s additional 10,000 cars imply roughly 12,000 extra metric tons of steel demand, before accounting for scrap recycling, efficiency gains, or substitution.
Pick‑and‑shovel strategy (practical idea)
Instead of buying companies that produce the final good, buy firms that supply essential inputs or services to the industry. Historical example: during gold rushes, tool sellers made steady profits even when many prospectors found no gold. Modern example: buying firms that make semiconductor equipment rather than betting directly on a single consumer electronics brand. Note: this reduces some product-level risk but does not eliminate sector or macro risk.
Special considerations and risks
– Breadth of use: A widely used input (e.g., crude oil, cotton) may show muted sensitivity to demand swings for one particular final use.
– Substitution and technological change: New materials or production methods can reduce the derived demand for an existing input.
– Time lags and inventory: Manufacturers may draw down inventories first, delaying any increase in input purchases.
– Price pass-through: Higher input demand can raise input prices, which affects margins and consumer prices.
– Concentration: If a small number of suppliers control an input, supply constraints can magnify price and availability effects.
Short checklist: evaluating a derived-demand opportunity
1. Identify the final-product demand trend (growing, stable, declining).
2. Estimate input intensity per unit of final product.
3. Calculate implied incremental input demand (use formula above).
4.