Connected Markets: How a Change in One Ripples to Others
Definition
Derived demand: demand for a good or factor of production that arises not for its own sake but because it is needed to produce or provide something else that is demanded.
- Markets are interrelated, so a change in one market affects others.
- Goods can be linked in demand or in supply.
- Recognising these links lets you trace how a shock spreads across markets.
Note
- Some goods are linked through demand, others through supply.
- A price change in one market shifts demand or supply in a connected market.
Five Ways Markets Are Linked in Demand or Supply
- Joint demand (complements)
- Goods used together, so a fall in the price of one raises demand for the other, such as cars and petrol in the UK.
- Competitive demand (substitutes)
- Goods that replace each other, so a dearer one raises demand for the alternative, such as UK shoppers switching from beef to chicken.
- Composite demand
- A good demanded for several competing uses, so more for one use leaves less for another, such as UK milk used for fresh drinking, cheese and butter.
- Derived demand
- Demand for a factor or input that comes from demand for a final good, such as demand for UK construction workers arising from demand for new housing.
- Joint supply
- Producing one good automatically produces another, such as UK beef and the leather that comes from the same cattle.
Example
- A fall in the price of cars, a case of joint demand, raises car use and so raises the demand for petrol, pushing up petrol prices.
- A rise in the demand for beef, which is in joint supply with leather, leads farmers to rear more cattle, raising the supply of leather and lowering its price.
- A poor UK wheat harvest raises bread prices and, through competitive demand, shifts some demand towards rice and pasta.
The Links Let You Trace Knock-On Effects
- They show that no market operates in isolation.
- They let you predict knock-on effects in connected markets.
- They connect product markets to factor markets through derived demand.
Evaluation: How Strong Is the Link?
- The strength depends on how closely the goods are related.
- Close substitutes or complements produce large knock-on effects.
- Weak links produce only minor ripples.
- The size of the ripple also depends on the cross elasticity of demand between the goods and on how quickly producers can respond.
Identify the Link Then Trace It
Exam technique
- Name the type of interrelationship first.
- Trace how a change in one market shifts demand or supply in the connected one.
- Use a concrete pair, such as cars and petrol, to anchor the analysis.
Common Mistake
- Do not confuse joint demand with joint supply.
- Joint demand links goods bought together, while joint supply links goods produced together.
- Do not treat markets as isolated.
- A change in one market shifts demand or supply in related markets.
Self review
- Define joint demand and give an example.
- Define competitive demand and give an example.
- What is derived demand?
- Give an example of joint supply.
- What determines how strong a market link is?
- Define composite demand and give a UK example.
