Hedonic Prices

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Hedonic Prices


Hedonic prices reflect the value of differences in the quality of goods. Hedonic price models provide a useful way of comparing the prices of heterogeneous goods of differing quality so long as consumers are not themselves using prices to judge quality (consumers are assumed in these models to compare the quality of goods independently of their prices). In hedonic models, goods are seen as being produced with different characteristics, and the quality of these goods reflects differences in the mixture of these characteristics. In making a purchase, consumers consider both the quantity of the good that they purchase and the quality of the good. The quality of the good is reflected in the price consumers are willing to pay. This tradeoff between quality and quantity is central both to models of hedonic prices and to household production theory.

In hedonic pricing models, both the characteristics and the prices are known. Differences in the prices of heterogeneous goods are viewed as reflecting quality differences resulting from different characteristics. For example, in a 1928 study, Frederick V. Waugh viewed the perceived quality of asparagus as being determined by the greenness of the asparagus and the size of the stalk. Greenness was held to be positively related to perceived quality, while stock size was held to be negatively related to perceived quality.

The price of other heterogeneous goods can be, and has been, similarly modeled as a function of a vector of characteristics of that good. Examples include automobiles, houses, and computers. To model the price of a particular version of a heterogeneous good, let Pi be its price, let Ci be a vector of m characteristics and let ei be a stochastic error term. If there are n different versions of the good, the price of each version might be written as:

Pi = β 0 + β 1 C 1 i + β 2 C 2 i + + βm C Cmi + ei

A hedonic price index can then be created as the characteristics and prices of the good change through time.

Hedonic price models have been applied to the construction of price indexes of goods such as automobiles, houses, and computers, for which the characteristics (quality) of the good have been changing over time. They have also been applied to estimates of the quality of life in different locations. The quality of regional amenities is assumed to be capitalized into housing prices and what is commonly thought of as the cost of living. Larry Sjaastad, in a 1962 article, argued that the only way that families can purchase the amenities that a location offers is to migrate to that location. Hence, housing prices are, in essence, the hedonic prices of those amenities. In 1979 Sherwin Rosen developed a hedonic method for measuring the quality of life within a region, based on the assumption that differences in regional amenities are capitalized by lower wage rates and higher housing costs for an amenity-rich region. A hedonic index of regional quality can then be estimated as a function of the characteristics of the location.

The hedonic model of regional quality is an extension of a model in public economics created by Charles M. Tiebout in 1956. Tiebout was concerned about the allocation of local public goods, and he developed a model based on the competition between locations for new residents. Cities attract residents by providing local public goods, and consumers are held to be aware of the public goods and the taxes of different regions, and they then move to the region that has the profile of public goods that maximizes their individual utility. Taxes are simply the prices of these public goods. Hedonic migration models extend Tiebouts model by including amenities provided by nature and the private sector alongside publicly provided amenities in determining the quality of life in various locations. Tiebouts model can also be made more general by including housing costs in determining the migration decision.

SEE ALSO Migration; Neighborhoods; Price Indices; Public Goods; Quality Controls; Regions; Taxes


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Michael P. Shields

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