Hedonic Regression - Hedonic Pricing Method

Hedonic Pricing Method

Certain environmental services often influence the market prices. The Hedonic pricing method is often brought into play in order to assess the economic values of such services.

This method finds its application to reveal the effect of environmental attributes in changes in the local real estate pricing. It is frequently used for estimating costs related to:

• The overall quality of the environment in terms of air pollution, water pollution and noise
• Environmental amenities which include aesthetic sights and closeness to recreational sites such as parks, beaches, etc.

It is important to note that the hedonic pricing method is based on the fact that prices of goods in a market are affected by their characteristics. For example, the price of a pair of pants will depend on the comfort, the cloth used, the brand, the fit, etc. So this method helps us estimate the value of a commodity based on people’s willingness to pay for the commodity as and when its characteristics change.

A particular example which is used most often is the real estate market where the value of two different properties (which can otherwise be compared) will vary depending on the various environmental amenities present in the surrounding areas of these properties. If there is a measurable price drop of properties located near a dump yard (as compared to other locations), the difference in the prices point towards the external cost of the dump yard. It is the marginal willingness to pay (in higher housing prices) for the given difference in cleanliness and serenity of the locality. Hedonic Regression methods are used to estimate these price differentials.

The Hedonic Pricing Method (HPM) as mentioned earlier is a form of revealed preference method of valuation and it uses surrogate markets to estimate the value of the environmental amenity.

Surrogate market is a concept that one uses when one cannot directly estimate the market prices for certain environmental goods. Therefore, a similar good sold in the market is chosen as a proxy.

For example, if we want to know the value of clean air estimated by an individual, he may reveal his preference in the form of establishing his house in a clean society and paying an extra premium for the same. Thus, with the help of Hedonic Pricing Method, the environmental component of the value and the market price can be separated. In turn, this market price is used a surrogate for the environmental value.