1 Hedonic pricing supposes that a good or service has a number of characteristics that individually give it value to the purchaser. The market price of the good is then assumed to be a function, typically a linear combination, of the prices of the characteristics. HEDONIC PRICING
2 Thus one has a relationship of the type shown, where P i is the price of the good, the X j are the characteristics, and the j coefficients are their prices. In principle, the j may themselves be market prices, but more often they are implicit. HEDONIC PRICING
3 Another example, responsible for much of the growth of the early literature, is the pricing of automobiles, with value being related to size, weight, engine power, etc. HEDONIC PRICING
4 Another example, responsible for much of the growth of the early literature, is the pricing of automobiles, with value being related to size, weight, engine power, etc. HEDONIC PRICING
5 Typically, the prices of the characteristics have to be inferred, and of course multiple regression analysis is an appropriate tool. HEDONIC PRICING
6 Given the prices of automobiles of a roughly similar nature with differing specifications, multiple regression analysis may be used to infer the prices of the more important characteristics. HEDONIC PRICING
7 The term ‘hedonic price index’ was coined in an early study of this type that analysed the pricing of automobiles in the 1920s and 1930s. HEDONIC PRICING
Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland HEDONIC PRICING It was prompted by the paradox that the price index for automobiles published by the Bureau of Labor Statistics showed an increase of 45 percent from 1925 to 1935, when it was obvious to everybody else that, in reality, prices had fallen dramatically.
9 HEDONIC PRICING The cause of the contradiction was the fact that the Bureau was using a very broad definition of passenger automobile that did not take account of the great improvement in average specification during the period. Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland
10 HEDONIC PRICING When one controlled for specification, the conclusion was exactly the opposite. Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland
11 HEDONIC PRICING The table presents representative data for eight manufacturers for their cheapest four- passenger vehicles in The sample is small but it will suffice for illustration. Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland
12 HEDONIC PRICING A regression of price on the characteristics yields the results shown (standard errors in parentheses). Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
13 HEDONIC PRICING The coefficients indicate that an extra pound of weight adds $1.13 to the value of a car, an extra inch of wheelbase $10.11, and one extra horsepower $18.28, with the weight and horsepower coefficients being significant at 1 percent level, despite the tiny sample size. Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
14 HEDONIC PRICING For an automobile in this category with the average specification of 2,981 pounds, 114 inch wheelbase, and 43 horsepower, the regression specification indicates a price of $2,869. (2,981 pounds, 114 inches, 43 bhp) 1920 fitted price, average spec.: $2,869 Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
15 HEDONIC PRICING The regression predicts a price of $2,573 in 1939, taking account of improved specifications and allowing for deflation caused by the Great Depression predicted price: $2,573 (2,981 pounds, 114 inches, 43 bhp) 1920 fitted price, average spec.: $2,869 Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
16 HEDONIC PRICING The actual average price was $795, lower by 70 percent, achieved by improvements in production technology and the exploitation of economies of scale, especially between 1920 and predicted price: $2, actual price: $795(2,981 pounds, 114 inches, 43 bhp) 1920 fitted price, average spec.: $2,869 Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
17 HEDONIC PRICING What are the uses of hedonic pricing? Obviously, a very important one is in the national accounts when, as in this example, one wishes to separate real effects from price effects over time predicted price: $2, actual price: $795(2,981 pounds, 114 inches, 43 bhp) 1920 fitted price, average spec.: $2,869 Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
18 HEDONIC PRICING Another is the determination of a fair price for a good or asset with multiple characteristics. In particular, when a property sales agent estimates the value of a house for sale, he or she is (or should be) intuitively applying a hedonic pricing model predicted price: $2, actual price: $795(2,981 pounds, 114 inches, 43 bhp) 1920 fitted price, average spec.: $2,869 Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland R 2 = 0.97 ^ price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
19 For another example, relating to the pricing of baseball players, see Michael Lewis’s Moneyball. HEDONIC PRICING R 2 = 0.97 ^ 1939 predicted price: $2, actual price: $795(2,981 pounds, 114 inches, 43 bhp) 1920 fitted price, average spec.: $2,869 Characteristics and factory price of cheapest 4-passenger car, 1920 weight wheelbase brake price ($) (lbs) (inches) horsepower Chrysler General Motors Graham–Paige Hudson Hupp Nash–Kelvinator Studebaker Willys–Overland price = – weight wheelbase horsepower (1667) (0.43) (23.64) (8.50)
Copyright Christopher Dougherty These slideshows may be downloaded by anyone, anywhere for personal use. Subject to respect for copyright and, where appropriate, attribution, they may be used as a resource for teaching an econometrics course. There is no need to refer to the author. The content of this slideshow comes from Section 3.6 of C. Dougherty, Introduction to Econometrics, fourth edition 2011, Oxford University Press. Additional (free) resources for both students and instructors may be downloaded from the OUP Online Resource Centre Individuals studying econometrics on their own who feel that they might benefit from participation in a formal course should consider the London School of Economics summer school course EC212 Introduction to Econometrics or the University of London International Programmes distance learning course EC2020 Elements of Econometrics