Derived Demand
What is Derived Demand?
Derived demand is the demand for a factor of production that results from the demand for the goods and services it helps produce.
The demand for a factor of production is derived from the demand for the final goods and services it is used to produce. If demand for the final product increases, the derived demand for the factors used to make it will also increase.
Derived Demand: a worked example
A bike shop assembles frames that each take 2 hours of labor. With weekly sales at 500 bikes, the shop needs 500 x 2 = 1,000 labor hours. A new commuter rebate pushes weekly sales to 800 bikes, so hours needed climb to 800 x 2 = 1,600. That extra 600 hours is 600 / 40 = 15 more full-time assemblers, and notice the wage never moved. The entire increase in labor demand came out of the product market.
The mistake students make with derived demand
Students often say labor demand rose because wages fell. A wage change moves the firm along its labor demand curve; it does not shift the curve. Derived demand shifts when something changes in the output market, such as the price of the final good, or when workers become more productive. The wage story is tempting because the wage is the price on the vertical axis of the labor graph, and in a product market a price change really does drive quantity demanded. Same logic, wrong curve.
Derived Demand questions
Is all labor demand derived demand?
Labor demand is always derived demand, because a firm hires a worker for the output that worker produces, not for the work itself. If nobody wanted the product, the firm would have no reason to hire at any wage. The same holds for land, capital and raw materials, which is why factor demand curves shift whenever demand for the final good shifts.
What is an example of derived demand?
Derived demand shows up whenever demand for an input tracks demand for the good it makes. Demand for cocoa beans comes from demand for chocolate, and demand for welders comes from demand for pipelines and ships. If chocolate sales slide, the cocoa market weakens even though nothing changed about cocoa itself, which is the whole point of the term.
How is derived demand related to marginal revenue product?
Derived demand is measured by marginal revenue product, which multiplies a worker's marginal product by the revenue each unit of output brings in. Because the product's price is one of the two multiplied terms, a rise in the price of the final good lifts MRP at every quantity of labor and shifts the whole factor demand curve to the right.
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Related terms
Common comparisons
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