Definition
Derived demand in finance refers to the demand for a good or service that occurs as a result of the demand for another related good or service. It is directly tied to the demand for an output of that good or service. For instance, the demand for timber is derived from the demand for building houses.
Key Takeaways
- Derived Demand refers to the demand for a good or service that comes indirectly from the demand for another good or service. It is strongly tied to the notion that this demand is a result of what the product can produce, and not the product itself.
- This concept is fundamental in production and industry where initial demand for raw materials or components is influenced by the final product’s demand. For instance, the need for steel is derived from the demand for cars and other machinery where steel is a significant production component.
- Demand fluctuations or changes in consumer preferences for the end product can significantly impact derived demand. Therefore, firms dealing with goods or services with derived demand need to constantly monitor the market trends of the end products they contribute to.
Importance
Derived Demand is an important finance term because it suggests a direct connection between the demand for a particular product or service with the demand for the inputs required for its production. Essentially, derived demand indicates that the demand for an item is driven by the demand for another product that it contributes to creating.
Understanding this concept enables businesses and investors to predict future market trends associated with the demand for commodities and services more accurately. For instance, an increased demand for new cars might result in higher demand for tires, glass, and steel.
Therefore, companies in those industries can anticipate a surge in their product’s demand. Being aware of derived demand can improve production planning, inventory management, and financial forecasting, contributing to the overall operational and financial efficiency of a business.
Explanation
Derived demand is a term most often used in economics to describe a case where demand for one good or service is derived from the demand for another related good or service. It plays a significant role in the supply chain where the demand for an original product creates demand for subsequent products necessary for production.
This concept simply explains the relationship between the demands of consumer goods and raw materials needed to produce them. The purpose of derived demand in finance is vital for guiding businesses in their production and pricing decisions.
For instance, if the demand for automobiles rises (due to factors like increase in consumers’ income, advancements in technology, or favorable government policies), it also drives increased demand for the steel utilized in their production. Businesses can study these patterns and estimate future demands for their products or components.
It can also help a business understand which products have a more elastic or inelastic demand, thereby informing pricing strategies. Hence, derived demand is essential in business planning, decision-making processes, and for predicting future market trends.
Examples of Derived Demand
Automobile Industry: The demand for steel, glass, rubber and other materials is derived from the demand for cars. If consumers have high demand for cars, the demand for these materials will also be high. On contrary, if fewer people want to buy cars, then there’s less demand for the materials that make them.
Construction Business: The demand for brick, cement, timber etc, is derived from the demand for a new building. If there’s high demand for new homes, offices, or other structures, the demand for these raw materials will be high. But, if the real estate market is down, there’s likely to be less demand for these building materials.
Digital Devices: The demand for a specific computer chip can be derived from the demand for the digital devices that use it. For example, if people want to buy the latest high-speed laptops, the computer chips inside them will also be in high demand. In turn, the materials to make this computer chip will also see an increase in demand.
FAQs on Derived Demand
What is the concept of Derived Demand?
Derived Demand specifies a product or service’s demand that arises due to the demand for another product or service. It is the demand for some physical or intangible thing where a market exists for both related goods and services in question.
What is an example of Derived Demand?
An example of Derived Demand would be the demand for coal which is a type of fuel. When the demand for electricity increases, the demand for coal would also increase because it is a major fuel source needed for power generation.
How does Derived Demand affect the finance industry?
Derived Demand plays a significant role in the financial sector. An increase in the demand for particular goods or services often results in an increase in demand for the workers required to produce those goods or services. As such, finance industries may experience changes related to employment rates and investment decisions pertaining to these variations in demand.
What is the relationship between Derived Demand and Elasticity?
Derived Demand is closely related to the concept of elasticity. In essence, if a good or service has a derived demand, that means the elasticity of demand for that good or service is likely to be very high. This means that changes in the price of the good or service can lead to significant changes in the quantity demanded.
How can businesses apply the concept of Derived Demand?
Businesses can utilize the concept of Derived Demand to forecast the market for their products or services, plan production and set prices. By understanding the factors that drive the demand for their products or services, companies can more effectively plan, budget and forecast.
Related Entrepreneurship Terms
- Supply Chain
- Intermediate Goods
- Economic Demand
- Market Equilibrium
- Pricing Strategy
Sources for More Information
- Investopedia: An extensive online resource focusing on finance and investing.
- Economics Help: A website dedicated to simplifying economics concepts and theories.
- Corporate Finance Institute: An educational institution devoted to financial training and certifications.
- The Economist: An international weekly newspaper printed in magazine-format, focusing on current affairs, international business, politics, technology and culture.
