Definition: Demand destruction occurs when the price of a product is higher than the historical average or when supply is limited for an extended period, leading consumers to switch to an alternative product. This results in a permanent or sustained decrease in demand for the original product.
How does demand destruction work?
Demand destruction happens when demand is reduced, or when consumers shift from that product or service to alternatives. This often occurs in cases of demand for oil or other energy goods such as ethanol.
If prices are the result of a temporary supply shortage, demand may not decrease permanently if few consumers switch to an alternative product before prices drop again.
For example, when the price of a bottle of water rises due to a snowstorm, the water company will face a decrease in demand, but not a sustainable decrease. When there are a limited number of delivery trucks to bring in new shipments of water, there will temporarily be fewer bottles of water available for purchase. As a result, the price of the bottle of water rises. However, a temporary increase in the price of water bottles may not lead to demand destruction if consumers are aware that the price increase is not permanent.
Consumer expectations regarding demand decrease are important when the product is sustained for a long time. If consumers believe that prices will remain high, they will look at alternative options, which can destroy demand for the original product.
Demand destruction can significantly affect the company producing the product that has lost demand. If consumers wish to buy fewer units of the product for an extended period, the producing company may have to reduce production and lay off workers.
Examples of demand destruction
Demand destruction usually refers to price increases in goods such as oil, fuel, and ethanol, but can also refer to demand for any product that has been permanently reduced.
For example, if gasoline prices continue to rise for a long time, consumers will shift from using gasoline vehicles to a more fuel-efficient option such as electric cars, public transportation, or even cycling.
As a result, consumers will have a sustained decrease in demand for gasoline because they do not need to purchase the same amount of gasoline as they previously did. When enough consumers make conscious decisions regarding fuel consumption to switch from gasoline, the demand for gasoline will be permanently lower. This permanent decrease in demand due to higher prices is demand destruction.
We can think of demand destruction in another way when we imagine that food delivery fees rise to $50 per order. You are likely to reduce the amount of food you order and switch to grocery shopping or picking up food from restaurants. In this scenario, high food delivery fees will lead to a sustainable decrease in demand.
In another scenario, imagine that the price of a box of strawberries has increased by $20. Would you continue to buy strawberries in the same quantity as you did before? Most consumers would probably switch to alternatives like raspberries or blueberries. Demand for strawberries will be destroyed due to the sustained high prices.
Demand destruction works the same way with oil and other energy goods.
What determines whether a product will face demand destruction?
Whether a product will face demand destruction depends on the elasticity of demand for it. If there are few alternatives to the product, the product is considered to have inelastic demand, meaning that as the price increases, the quantity demanded decreases at a slower percentage rate.
In
In this case, consumers may be forced to purchase the product even if prices remain high for a prolonged period. However, if there are many alternatives to the product (elastic demand), consumers will be more inclined to abandon the product due to the higher price and switch to an alternative. The elastic demand for the product can contribute to demand destruction.
Note: Another factor contributing to demand destruction is household wealth. If prices are rising on certain goods while wages or wealth do not keep pace with inflation, consumers will be more likely to reduce their purchasing.
Frequently Asked Questions (FAQs)
What is demand?
Demand in economics is the desire and ability of consumers to purchase goods or services. It is the underlying force behind economic growth and expansion. According to the law of demand, demand and price are related so that demand increases when price rises, provided all other factors remain equal.
What is oil demand destruction?
Oil demand destruction is when the demand for oil is permanently reduced due to sustained high prices or low supply, and consumers shift to alternative products such as electric cars.
Was this information helpful?
Thank you for your feedback! Please let us know why!
Sources:
– Federal Reserve Bank of Kansas City. “Tenth District Energy Activity Expanded Moderately.”
– Federal Reserve Bank of Dallas. “High Fuel Prices in the U.S. May Crimp Oil Demand Soon.”
– Federal Reserve Bank of San Francisco. “What Are the Possible Causes and Consequences of Higher Oil Prices on the Overall Economy?”
Source: https://www.thebalancemoney.com/what-is-demand-destruction-6834281
Leave a Reply