What is Demand Destruction and How Does It Work?

Regardless of whether you drive, most of us are acutely aware of gas prices, especially when they’re on the rise. And when these prices continue to increase car owners search for substitutes to save money, like switching to gas-efficient cars or taking public transportation.

This phenomenon can be described by an economic theory called demand destruction, where the demand for a product decreases due to high prices, and shoppers seek alternatives. But how does demand destruction impact our daily lives? Keep reading to learn more about demand destruction, its impact on the energy industry, and how it plays a role in economic growth.

Demand destruction refers to the permanent or sustained decline in demand for a service or a good. Lower demand occurs due to high prices or a limited product supply. As a result of high prices, people seek alternatives or cease using a product entirely to save money. Therefore, consumers change their buying behavior to respond to market changes.

The decrease in demand for a product or service can lead to reduced economic activity and growth, says Dennis Shirshikov, an economics professor at the City University of New York. “Examples of demand destruction include changes in consumer behavior, such as reduced travel due to the pandemic, or technological advancements that render certain products or services obsolete.”

Demand destruction is often discussed in the context of the energy industry. For example, how the demand for gasoline affects gas prices. As gasoline prices increase, car owners are more inclined to switch to electric vehicles or public transportation. If gas prices remain high for too long, more consumers will have bought a gas-efficient car, and the gasoline demand will be permanently reduced or even permanently destroyed.

More often than not, demand destruction permanently destroys the demand for the good. For example, in the late 1800s, whale oil was the primary source of heat and light. However, the price of whale oil was incredibly high, making it unaffordable for most consumers. With the introduction of crude oil, whale oil was phased out as a fuel source.

That being said, there are several instances where demand destruction is temporary, especially if the consumer understands that higher prices are temporary due to a shortage. Even with a temporary block, demand destruction creates a ripple effect that increases demand for new alternatives and thus expands the economy.

Inflation causes price increases across all sectors of the economy. However, the demand for a product is only destroyed if there is a change in consumer behavior. If there is a reduced need for a product during times of inflation, a product is said to have experienced demand destruction.

Whether a product undergoes demand destruction depends on the elasticity of the product. People will continue to buy the product despite high prices when it has inelastic demand. For example, despite the increasing cost of prescription drugs, the demand stays the same because people are willing to absorb the cost of their medication.

When a product has elastic demand, that means price heavily influences the demand for a product. This theory states that lower prices lead to a higher demand for a good and vice versa. So, for instance, while you may be willing to pay a little more for your medication, the same may not be said for a particular grocery item or makeup product.

Demand destruction could mean consumers are phasing out their dependence on gas with the rise of a more fuel-efficient option. Oil companies may increase oil production to increase the supply and reduce its prices in the long term.

As prices for oil increase, the demand for oil decreases as other energy commodities populate the market. Morgan Stanley predicted that $80 per barrel would cause oil’s demand destruction, but with prices over $100, demand destruction for oil is evidently higher.

Inflation plays a large part in whether or not a product is destroyed in demand. However, inflation doesn’t have to erode the power of your dollar.

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