According to the business dictionary, “Derived demand is used to refer to a situation where demand for a certain product or service occurs as a result rising demand of another product or service.” In most practical situations, it occurs when one product or service depends on another for production. For instance, demand for bread leads to derived demand for wheat, because wheat must be produced for bread to be made.
Economists would conclude that, “As demand for bread increases, so does its price.” The same is translated to an increase in the price of wheat used to make bread. Another scenario that can be used to illustrate derived demand is the transport sector. People are always engaged in transport activities not because they enjoy travelling, but because they are going to be involved in other consumption activities at some place.
Economists state that, “Derived demand applies to consumers and producers.” Employees are hired in companies not because they are wanted, but to use their skills for productivity purposes. This implies that employers have a derived demand for employees. Another example is a case of a farmer in demand of manure. They need it to enhance production of crops, which is the main source of livelihood. Therefore, for his own livelihood, he demands manure. It is therefore the derived demand of manure to enhance crop production.
Derived demand is used to factor in all factors of production in an economy. It creates a clear picture of how producers consider several factors in determining prices of commodities by factoring in costs of production, transport and demand by consumers.
A question that is most commonly asked by people is, why does the demand of a final product increase the demand of factors of production? That is, how does adjustment in price of a product affect the overall demand? If for instance, the demand for umbrellas in the demand curve shifts to the right, while the supply curve remains constant, then a balanced price and quantity of umbrellas in the market would trade at a higher price which might also lead to increased production of umbrellas for sale to people.
As a result of an increase in price, profits gained by producers per unit of umbrellas would increase, which would appeal to them to manufacture more umbrellas until the cost of production rises to surpass the cost of production of the last umbrella in order to be equivalent to the new price.
In future, when I set up my own businesses the concept of derived demand would be very important for making decisions. As discussed earlier, I would use factors of production in the market to set affordable, attractive and competitive prices for my products.
For instance, I intend to set up a floor mill company in future. By using this concept of derived demand, I would be able to make good decisions on man power hiring, the prices of maize and other commodities necessary for production and a good location to facilitate nearness to raw materials and transportation costs.
From the explanation of derived demand, putting into consideration these factors would enable my business thrive in the face of competition because I would have factored in almost all factors necessary for production. At the same time, understanding this concept has given me an eye opener that I should always research the market in order to monitor the dynamics of prices, demand and cost of production.