A Primer on the Role of Demand in the U.S. Economy

What is Demand?

Demand drives everything in the economy. All businesses try to understand or guide consumer demand, so they can be the first or the cheapest in delivering the right products and services. If something is in high demand, businesses make more. If they can’t make more fast enough, the price goes up.

Demand can be measured by a country’s:

• Total production of goods and services,
• Minus its exports, which are demanded by other countries,
• Plus its imports, which are the items it doesn’t make at home.

Measured this way, U.S. economic demand is over $14.2 trillion, which is just over 20% of the world’s total demand. The next largest country, China, has a demand of $7.97 trillion, while Japan's demand is $4.3 trillion.

America Has Been the World’s Best Customer

Right now countries need America because we are the largest importer, at $2.1 trillion, twice as large as either Germany ($1.2 trillion), the next largest importer or China ($1.1 trillion), the world’s third largest importer. Because of this role, all countries have an interest in maintaining good relations with the U.S., and in keeping our economy healthy. (Source: CIA World Factbook, 2008 estimate)

Why the U.S. Imports so Much

The key component of demand is consumer goods and services. Whereas the U.S. supplies all of its own services, it imports goods that can be made more efficiently overseas, such as industrial supplies, oil, telecommunication equipment, autos, clothing and furniture. It is often said that the U.S. has lost its competitive edge in producing these products, and has become a service-oriented economy. The key driver of demand growth is economic growth. Here’s how it works. As incomes rise, people are able to buy more. As people buy more, companies can make more, and then pay employees more. The ideal situation is healthy growth without inflation, which has been the situation in the U.S. for the last five years.

U.S. Demand Could Decline

Since demand is dependent on personal income and wealth, a decline in wealth will lower demand. In fact, the Federal Reserve reported that the median net worth per family rose only 1.5% from 2001 to 2004. Since net worth did not keep up with inflation during these years, the average household feels poorer. Although demand grew, it was financed by home equity loans. As a result, overall debt and debt servicing took a larger percent of family income. In fact, the number of late payments (60+ days) increased, especially among the bottom 80% of the income distribution.

As the housing market declined, this reliance on debt has resulted in a decline in U.S. demand.

Foreign Demand Could Increase

Before the 2008 - 2009 recession, the Organization for Economic Cooperation and Development (OECD) predicted demand in China, India and Russia would grow, thanks to increasing population and personal income. Demand in the U.S., Japan, and Brazil was slowing, even before the recession. The U.K. and the Euro area had mixed indicators, which portended moderate growth. This trend should resume after the recession is over.