Introduction
In economics, the term “derived demand” is often used when talking about factors of production such as labour, land, capital, and entrepreneurship. These inputs are not demanded for their own sake, but because they help produce goods and services that people want. Understanding the concept of derived demand helps explain why changes in consumer demand affect the demand for resources used in production.
What is Derived Demand?
Derived demand refers to the demand for a factor of production or input that arises from the demand for the final goods and services it helps to produce. In other words, the demand for labour, machinery, raw materials, etc., is dependent on the demand for the product they help produce.
Example:
Suppose there is high demand for electric cars. To produce these cars, companies need workers (labour), machines (capital), and raw materials like lithium (land/resource). Therefore, the demand for these factors increases because of the rise in demand for electric cars.
Characteristics of Derived Demand
- Indirect Demand: It does not arise directly but comes from the demand for consumer goods.
- Dependent Nature: It depends on the final product market.
- Chain Reaction: A change in consumer preferences can trigger changes in multiple input markets.
Factors Affecting Derived Demand
- Price of the Final Product: If the final product’s price rises and becomes more profitable, the demand for inputs increases.
- Productivity of the Factor: If an input becomes more efficient, its demand increases.
- Availability of Substitutes: If a cheaper input becomes available, demand for the current factor may decrease.
- Technology: New technology can increase or reduce the need for certain factors.
Importance of Derived Demand
- Helps firms in resource planning and employment decisions
- Shows how the labour market is connected to the goods market
- Helps policymakers understand the impact of changes in product demand on employment
Applications of Derived Demand
1. Labour Market: A restaurant does not hire waiters unless there are customers. So, the demand for waiters depends on the demand for food served in the restaurant.
2. Raw Materials: The demand for steel depends on the demand for cars, buildings, and bridges.
3. Capital Goods: Machinery is purchased when there is demand for the goods it helps produce.
Conclusion
In conclusion, the demand for factors of production is a derived demand because it is based on the need to produce goods and services that satisfy consumer wants. This concept is vital in understanding how changes in the product market affect the input markets. It highlights the interconnection between different sectors of the economy and helps businesses and governments make informed decisions regarding employment and resource allocation.