Derived Demand

What it is

Derived demand is the demand for a good or service that exists because of the demand for another, related good or service. In other words, demand for an input (labor, raw materials, components, machinery, or services) is driven by demand for the final product that uses that input.

How it influences markets

Because inputs are demanded only insofar as they help produce final goods or services, changes in demand for a final product ripple through its supply chain:
* When final-product demand rises, demand (and often price) for inputs typically rises.
* When final-product demand falls, demand for related inputs typically falls.
* The effect can be amplified across sectors that supply critical inputs (e.g., energy, raw materials, specialized labor).

Key components

Derived demand primarily concerns:
* Labor — workers needed to produce the final good or service.
* Raw materials — unprocessed resources used in production.
* Processed materials and intermediate goods — components fabricated from raw inputs.

Examples

• Pick-and-shovel (Gold Rush) — During a boom for a final product (gold), tools and services sold to prospectors (picks, shovels, supplies) experienced increased demand. Investing in those suppliers is an example of targeting derived demand.
• Computer market — Growth in computer purchases creates derived demand for internal components (motherboards, GPUs), peripherals (monitors, mice), and the materials used to make them.
• Textiles example — A spike in demand for a particular fabric pattern may not strongly affect overall cotton demand if cotton is widely used across many products; scope of use moderates the derived-demand effect.

Factors that affect the strength of derived demand

• Scope of use — Inputs used across many products are less affected by demand swings for any single final good.
• Substitutability — Readily substitutable inputs reduce sensitivity to changes in one final product.
• Production lead times and inventories — Large inventories or long production lags can blunt short-term derived-demand signals.
• Vertical integration and supply-chain structure — Firms that produce inputs internally will alter how demand is transmitted across markets.

Derived vs. direct demand

• Direct demand: demand for a final good or service by end users.
• Derived demand: demand for an input that exists because it is required to produce a final good or service.

Investment and planning implications

• Forecasting: Understanding derived demand helps firms and investors anticipate needs for inputs when final-product demand shifts.
• Pick-and-shovel strategy: Investors can reduce exposure to the risks of an end-product market by investing in suppliers, tools, or infrastructure that serve that market. However, this strategy still carries risk—suppliers can lose revenue even when derived demand appears strong, due to competition, substitution, or operational issues.
• Supply-chain decisions: Manufacturers can plan sourcing, capacity, and labor strategy by tracking signals from end-market demand.

Key takeaways

• Derived demand links input markets to final-product markets: changes in one drive changes in the other.
• The effect depends on how specific or widely used an input is, substitutability, and supply-chain characteristics.
• For businesses and investors, recognizing derived-demand relationships enables better forecasting, allocation of resources, and strategic positioning in related markets.