1 Hedonic pricing supposes that a good or service has a number of characteristics that individually...

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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

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Thus one has a relationship of the type shown, where Pi is the price of the good, the Xj are the characteristics, and the bj coefficients are their prices. In principle, the bj may themselves be market prices, but more often they are implicit.

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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.

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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.

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Typically, the prices of the characteristics have to be inferred, and of course multiple regression analysis is an appropriate tool.

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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.

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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 .

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Characteristics and factory price of cheapest 4-passenger car, 1920

weight wheelbase brake price ($) (lbs) (inches) horsepower

Chrysler 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

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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.

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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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

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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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

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HEDONIC PRICING

The table presents representative data for eight manufacturers for their cheapest four-passenger vehicles in 1920. 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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

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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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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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.

1939 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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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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 1925.

1939 predicted price: $2,5731939 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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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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.

1939 predicted price: $2,5731939 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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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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.

1939 predicted price: $2,5731939 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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

R2 = 0.97

^ price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

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For another example, relating to the pricing of baseball players, see Michael Lewis’s Moneyball.

HEDONIC PRICING

R2 = 0.97

^

1939 predicted price: $2,5731939 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 3100 117 45 3170General Motors 2739 112 44 2435Graham–Paige 3150 119 43 3260Hudson 2955 109 55 3010Hupp 3400 123 45 3400Nash–Kelvinator 3455 121 35 3285Studebaker 2900 112 45 2780Willys–Overland 2152 100 35 1675

price = –2441 + 1.13 weight + 10.11 wheelbase + 18.28 horsepower (1667) (0.43) (23.64) (8.50)

Copyright Christopher Dougherty 2012.

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2012.10.29