What Is Demand Destruction?

  • 7 min read

So what is demand destruction, and how is it related to inflation and the economy? You may hear this term more frequently in the news. You may hear it related to inflation and gas prices. Demand destruction means that, at some point, increased prices for any item, whether it’s gasoline, vehicles, or groceries, cause people to purchase fewer of the product. 

For example, if you are a motorist or a driver, you have a vehicle, and normally you would drive, let’s say, 1500 miles a month going back and forth to work. I go away on weekends and the gas price is $3, $4, and $5 for some period of time. You will continue to drive 1,500 miles a month and your fuel cost per month will kind of go up. For example, if you have a vehicle that gets 30 miles per gallon and you drive 1,500 miles per month, you will use 50 gallons per month. So if the gas price is $3 x $50, you spend $150 a month on gas. And then it goes up to $4 for 50 gallons. Now you’re spending $200 a month on gas.

Well, it’s $50 more and then it goes up to $5 per gallon. At some point, you’re spending two hundred fifty a month on gas. Your monthly gas bill where you put money in the tank is going to get to the point where you’re going to start taking fewer trips. You’re going to start driving less. You may still have to go back and forth to work. You may still have to go to appointments. 

However, you may decide on the weekend. Maybe we won’t drive to the mountains. Maybe we won’t take that trip to the beach. And you’ll start to consume less. It doesn’t happen right away with pricing. Similarly, you may go to the grocery store with the same shopping list every week. And your grocery bill might be 200 bucks or 250 bucks and then the next month it’s maybe two 60s or two 80s. At some point, you’ll notice that the prices of these items have gone up to the point where you’re going to purchase fewer of them.

Again, it doesn’t happen right away. Most of the time, people will continue to buy the same items they purchased or maybe a lower-priced version of them. That’s not demand destruction, that’s a modification of buying. That is switching products. Demand destruction happens when consumers start to purchase fewer items overall. They buy fewer products like gasoline. And this is what is beginning to happen now. 

So what does demand destruction do for the economy? Well, it makes it worse. Here’s why: if, for example, a grocery store sells 50 sirloin steaks every day, and as demand destruction sounds exactly like what it is, it’s the destruction of the demand. starts to erode the next day. Maybe they sell 40, and maybe it drops down to 30. So at some point, the volume of steaks that they sell drops to maybe half of what it was.

What that means is they’re going to order fewer of that product, and the same can hold true for paper towels, cans of beans, or any product for that matter. So the manufacturers of that product will start to produce less as they see the demand go down. This does not happen right away. It may take weeks, months, or sometimes a year for people to adjust their buying habits. 

At first, they’re just going to spend the extra money. Take it from their budget, especially in 2021. There were a trillion dollars. It’s estimated that $10 trillion of stimulus money went into the economy. 5 trillion went directly to stimulus and enhanced unemployment. Another 5 trillion was from the Fed putting money into the financing vehicles’ financing capacity. So $10 trillion went into the economy. That money is now being absorbed, being soaked up.

So demand destruction doesn’t happen right away because people have the extra wealth. That extra money goes away. People have started to spend less. What’ll happen next is that the manufacturers of these products will cut back on the retailers of these products. In their business, the grocery store might need fewer staff. They might need to purchase fewer products. They might need to buy fewer shopping carts to replace old ones.

Each level of that economic reduction will be like a domino effect. The grocery store may have had 30 employees. Now they have cut it down to 28. Their shopping carts don’t wear out as fast, so they don’t buy new carts. The cart company has to lay off employees. That’s where a recession comes in and maybe even a depression. If it spirals downward in volume now, it may not reduce the price. That’s one of the things that’s happening now in the economy. 

Normally, supply and demand affect pricing, but when you’re in a fully incentivized economy where the government has adjusted interest rates and is putting stimulus into the economy, even if you sell less, you can’t reduce your price anymore because the grocery store is already operating on a small margin. The meat factory that you know cuts up cows and puts them into sirloin steaks. They can’t sell the stakes for any less because their costs are at the maximum they can be to still sell them for the same price. Normally, demand would lower prices, but demand destruction

In an inflationary environment, this means that prices have to stay high, so it’s not going to lower prices. In fact, some manufacturers, wholesalers, or retailers might have to raise prices. Because if they’re not selling as many items, they have to charge more for each item. Remember the old adage, “We sell cheap, but we make it up in volume?” The high-volume car dealership furniture store says they can sell it cheap because they sell so many. They only need to make a little bit on each thing they sell. Well, if you’re now in a store and your volume is going down, you can’t just make a little bit on each item. You have to make more on each thing you sell to pay your bills. You pay for your electricity. mortgage, or whatever your fixed costs are. 

If you sell fewer stakes at a grocery store and your mortgage doesn’t go down, you may be able to cut back on employees. You may be able to maybe have less electricity because, you know, you don’t have as many things in the cooler. I don’t know, your rent doesn’t go down. Your mortgage does not go down. Your insurance does not go down, so you might actually have to raise prices. In order to keep your fixed expenses paid, demand destruction.

There is an insidious factor in the economy which could lead to the exact opposite of what most people would expect. And that is lower prices. When there’s less volume of sales, let us know what you think in the comments. Are you seeing this? In your own life, are you buying fewer things? Are you buying less gasoline yet? Even though gas has gone from maybe $3 to $5 in your area, are you still putting the same amount of gas in your car or are you starting to cut back on trips? Are you starting to drive less for carpooling? Are you buying fewer things at the supermarket? Tell us what you think.

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