Derived Demand

Goods and services are sometimes acquired because they are important inputs in the manufacture and distribution of other products. The outputs of engineers, production workers, sales staff, managers, lawyers, consultants, office business machines, production facilities and equipment, natural resources, and commercial airplanes are all examples of goods and services demanded not for direct consumption but rather for their use in providing other goods and services. Their demand is derived from the demand for the products they are used to provide. Input demand is called derived demand.

The demand for mortgage money is an example. The quantity of mortgage credit demanded is not determined directly; it is derived from the more fundamental demand for housing. The demand for air transportation to resort areas is not a direct demand but is derived from the demand for recreation. Similarly, the demand for producers' goods and services used to manufacture products for final consumption is derived. Aggregate demand for consumption goods and services determines demand for the capital equipment, materials, labor, and energy used to manufacture them. For example, the demands for steel, aluminum, and plastics are all derived demands, as are the demands for machine tools and labor. None of these producers' goods are demanded because of their direct value to consumers but because of the role they play in production.

Demand for producers' goods and services is closely related to final products demand. An examination of final product demand is an important part of demand analysis for intermediate, or producers,' goods. For products whose demand is derived rather than direct, demand stems from their value in the manufacture and sale of other products. They have value because their

MANAGERIAL APPLICATION 4.1

How the Internet Affects Demand and Supply

From an economic perspective, the Internet is the enemy of high prices and high profit margins. By greatly expanding the scope of the market, the Internet effectively eliminates geographic boundaries, especially for easily transported goods and services. This greatly increases the elasticity of demand and supply.

For example, in the pre-Internet era, anyone looking for a good deal on a high-quality vacuum cleaner might have gone to the local Wal-Mart, Target, or a specialty shop to look for the best bargain available. With the Internet, consumers can log onto Google.com, or your favorite Internet search engine; do a search on vacuum cleaners; and get data on hundreds of high-quality vacuums at extremely attractive prices. For example, with $15 to $20 for shipping via Federal Express or UPS, it is possible to have vacuums delivered in Lawrence, Kansas, from http://www.vacdepot.com/ in Houston, Texas, at prices far below those offered by the local vacuum cleaner shop.

Successful Internet retailers offer bargain prices, a broad assortment of attractive products, and speedy delivery. They also effectively handle returns and basic customer service. Of course, traditional retailers cannot stand idly by as Internet-based retailers drive them out of business. They must fight back with competitive prices, high-quality products, and an enticing in-store shopping experience. Borders is a good example of a bookseller that has effectively distinguished itself from Amazon.com and other Internet retailers by offering an appealing in-store shopping experience.

When considering the economic potential of Internet-based commerce, it is important to keep in mind that successful firms use Internet technology to maintain significant competitive advantages. The Internet, by itself, seldom confers long-lasting competitive advantages. The Internet is a marvelous communications device that greatly improves access to information about product quality, prices, and performance. The Internet broadens the market, and makes demand and supply much more sensitive to changing economic conditions.

See: Kristi Essick, "Young Guns Get Creative in Life After Venture Capital," The Wall Street Journal Online, December 7, 2001 (http://online.wsj.com).

employment has the potential to generate profits. Key components in the determination of derived demand are the marginal benefits and marginal costs associated with using a given input or factor of production. The amount of any good or service used rises when its marginal benefit, measured in terms of the value of resulting output, is greater than the marginal costs of using the input, measured in terms of wages, interest, raw material costs, or related expenses. Conversely, the amount of any input used in production falls when resulting marginal benefits are less than the marginal cost of employment. In short, derived demand is related to the profitability of using a good or service.

Regardless of whether a good or service is demanded by individuals for final consumption (direct demand) or as an input used in providing other goods and services (derived demand), the fundamentals of economic analysis offer a basis for investigating demand characteristics. For final consumption products, utility maximization as described by the theory of consumer behavior explains the basis for direct demand. For inputs used in the production of other products, profit maximization provides the underlying rationale for derived demand. Because both demand models are based on the optimization concept, fundamental direct and derived demand relations are essentially the same.

demand function

Relation between demand and factors influencing its level

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