What Is Demand Destruction?

How Does Demand Destruction Work?

Demand destruction occurs when demand is reduced, or when consumers switch from that product or service to alternatives. It often occurs with demand for oil or other energy commodities like ethanol.

If prices are caused by a temporary lack of supply, demand may not be reduced permanently if few consumers switch to an alternative product before prices fall back down.

For example, when the price of a case of water rises due to a snowstorm, the water company will face a drop in demand, but not a sustained one. When there are limited delivery trucks to bring in new shipments of water, there temporarily will be fewer cases of water available to buy. As a result, the price of a case of water rises. However, a temporary rise in water-bottle prices may not cause demand destruction if consumers are aware that the increase in the price is not permanent.

Consumer expectations matter for the demand for a product to decline for a sustained period. If consumers believe prices will remain high, they will consider alternative options, which can destroy demand for the original product.

Demand destruction can severely impact the company that produces the product that lost demand. If consumers want to purchase fewer units of a product for a longer period of time, then the company that produces it may have to reduce production and lay off workers.

Examples of Demand Destruction

Typically, demand destruction refers to the increase in prices in commodities such as oil, fuel, and ethanol, but it can refer to demand for any product that has been permanently lowered.

For example, if gasoline prices remain high for an extended period of time, consumers will switch from using gasoline vehicles to a more fuel-efficient option, such as electric vehicles, public transportation, or even biking.

As a result, consumers will have a sustained decrease in their demand for gasoline because they do not need to purchase the same amount of gasoline as before. As enough consumers make fuel-conscious decisions to switch from gasoline, the demand for gasoline will be lower permanently. This permanent decrease in demand due to higher prices is demand destruction.

Think of It Like This

Another way to think of demand destruction would be to imagine if the fee for delivery food rose to $50 per order. You would likely cut back the amount of delivery food you buy and shift to grocery shopping or picking up your food from restaurants. In this scenario, the high price of delivery food would lead to sustained lower demand.

In another scenario, imagine that the price of a pint of strawberries increased by $20. Would you continue to buy strawberries in the same quantity as before? Most consumers would probably switch to alternatives such as raspberries or blueberries. The demand for strawberries would be destroyed due to sustained higher prices.

Demand destruction works in similar way with oil and energy commodities.

What Determines if a Product Will Face Demand Destruction?

Whether a product will experience demand destruction depends on its elasticity of demand. If there are few substitutes for a product, then the product is said to have an inelastic demand, meaning that as the price increases, the quantity demanded decreases at a slower rate in percentage terms.

In this case, consumers may be forced to still buy the product even if prices remain high for an extended period of time. However, if there are many substitutes for a product (elastic demand), then consumers will be more likely to abandon the product with the higher price and switch to an alternative. A product's elastic demand can contribute to demand destruction.

Frequently Asked Questions (FAQs)