The Expert Podcast

So what is demand destruction and how is it related to inflation and also the economy? You may be hearing this term more frequently in the news. You may hear it related to inflation and gas prices. What demand destruction means is, at some point, increased prices for any item—whether it's gasoline, vehicles, real estate, insurance, groceries—starts to have people purchasing less of the product.

So for example, if you are a motorist, a driver, you have a vehicle, and normally you would drive, let's say, 1500 miles a month going back and forth to work, going away on weekends. And the gas price is three dollars, then four dollars, then five dollars. For some period of time, you will continue to drive 1500 miles a month, and your fuel cost per month is going to go up.

For example, if you have a vehicle that gets 30 miles per gallon and you drive 1500 miles per month, you use 50 gallons per month. So if the gas price is three dollars times fifty gallons, you spend 150 a month on gas. Then it goes up to four dollars times 50 gallons—now you're spending 200 a month on gas. Well, it's 50 more. And then it goes up to five dollars per gallon—now you're spending 250 a month on gas.

At some point, your monthly gas bill—that you put money in the tank—is going to get to be 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. Same thing with groceries. You may go to the grocery store and have the same shopping list every week, and your grocery bill might be 200 bucks, 250 bucks, and then the next month it's maybe 260, and then 280. And at some point, you'll notice that the prices of items have gone up to where you're going to purchase less 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 it.

That's not demand destruction—that is modification of buying, that is switching products. Demand destruction happens when consumers start to purchase less overall. They buy fewer products—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 destruction of the demand—starts to erode the volume of steaks.

Next day, maybe they sell 40, and maybe it drops down to 30. So at some point, their volume of steaks that they sell drops down to maybe half of what it was. What that means is they're going to order less of that product. And the same can hold true for paper towels, or 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, 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 was trillions of dollars. It's estimated that 10 trillion dollars 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, the financing capacity. So 10 trillion dollars 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 money.

Once that extra wealth, that extra money, goes away, people start to spend less. What will happen next is the manufacturers of these products, the retailers of these products, will have to cut back on their business. The grocery store might need less staff. They might need to purchase less product. 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 maybe has 30 employees—now they cut down to 28. And their shopping carts don't wear out as fast, so they don't buy new carts. And the cart company has to lay off employees. And that's where a recession comes in—and maybe even a depression. Because now you have two more unemployed people. They're certainly going to have demand destruction in their life. And it becomes a deepening spiral to where these products go down 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 affects pricing. But when you're at a fully incentivized economy, where the government has adjusted interest rates and put stimulus in 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 cuts up cows and puts it into sirloin steaks—they can't sell the steaks for any less because their costs are at the maximum they can be to still sell it for the same price. Normally demand would lower prices, but demand destruction in an inflationary environment means that the prices have to stay high.

So it's not going to lower the prices. In fact, some manufacturers or 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 that old saying, “We sell cheap, but we make it up in volume,” right? The high-volume car dealership, furniture store—they say they can sell cheap because they sell so many. They only need to make a little bit on each thing they sell.

Well, if you're now a store where 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: your rent, your electricity, your mortgage—whatever your fixed costs are. If you sell fewer steaks at a grocery store, 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 don’t have as many things in the cooler—I don't know—but 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.

So demand destruction 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 three dollars to five dollars 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, carpool? Are you buying fewer things at the supermarket?

Tell us what you think. We’ll see you in the next video.