Demand Destruction

I have heard the term “demand destruction” quite a bit over the past year in the context of high oil prices.  Usually it is some analyst or commentator on CNBC.  It seems like it is used enough to warrant a closer look.  So let this be in the spirit of a William Safire On Language column, but for a phrase bandied about in the economic world.  Usually it starts like this, “today oil prices rose another 10%.  At what point do the oil companies have to worry about demand destruction?”  In economics, when the price of a good increases, for most goods, the quantity that people want to buy decreases.  The reason for this arises from the fact that when people are trying to make the best decision, they consume a good up to their willingness to pay.  If they consumed any more, they would be worse off.  So, assuming people consume oil-derived products (read gasoline) up to this point, when the price of oil increases, they decrease the amount of gas (however small) they buy.  This is basic economics fare.

Now, there are two possibilities for the meaning of “demand destruction.”  Either it is a sexy term for the process that I just described.  One has to admit “demand destruction” is a wonderful choice of words.  The harsh-sounding, alliterated “dee” sound.  Destruction even sounds like what it is.  Say it, “de-struc-tion.”  As the syllables roll off the tongue, you get the feeling that barrels of oil are combusting out in the desert.  This phrase is almost in league with “credit crunch.”

The alternative meaning for this diminishing term is that when the price of oil rises, something altogether different happens than the process described above, people choose to irrevocably decrease the quantity of oil-derived products they buy.  This would imply that when the price of oil rises by 10%, people reduce the quantity of these products consumed by 1% permanently, since, presumably, they decide to walk to the mailbox instead of SUVing it.  This is in stark contrast to the textbook consumers who continually adjust their consumption levels based on current prices.  So what do the talking heads on CNBC mean?

I would venture to guess that most of the time, in the context of short term price fluctuations which are talked about most frequently, these gurus are simply jazzing up the textbook economics consumer.  Just by saying, “demand destruction,” anyone can get the essence.  Having said that, I (and people who are vested in oil) would be more interested when the alternate behavior, that of people irrevocably reducing consumption, occurs.  One has to think that with the continual increases in oil prices, that consumers will at some point decide, quite rationally, that they should take steps to permanently reduce their oil consumption.  I would call this true “demand destruction.”  It seems fitting that such a term deserves a different phenomenon with which to be associated.

Spread the word everyone, demand destruction is coming!