Hedonic Pricing - Explained
What is Hedonic Pricing?
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Table of ContentsWhat is Hedonic Pricing?How Does Hedonic Pricing Work?Advantages and Disadvantages of Hedonic PricingExample of Hedonic Pricing
What is Hedonic Pricing?
Hedonic pricing is a pricing model that gives consideration to non-market characteristics and external factors with respect to how they affect market prices. Hedonic pricing recognizes that the market prices of goods are determined by both internal and external factors. According to this model, the sum total of the price of a good is determined by the internal attributes and external characteristics of the good which cannot be sold separately. The hedonic pricing model also estimates the values of the ecosystem or environmental services that affect the prices of goods. This pricing model is used to estimate how external factors influence the decision of consumers to purchase certain products and how much they are willing to pay for it because of those factors.
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How Does Hedonic Pricing Work?
The Hedonic pricing model is often used in the housing market to explain the variations in the prices of pieces of land and buildings. This pricing model considers the price of houses or other goods as a summation of internal attributes and external characteristics that are inseparable from the product or cannot be sold differently from the product. For instance, in the housing market, the price of a house can be affected by ecosystem or environmental factors such as the scenic views of the house, its location, and neighborhood, the appearance of the house among other factors. The hedonic pricing entails a series of data collection on the good which includes the specification, characteristics or attributes of the goods. For instance, to determine the price of a piece of land, the estate surveyor or seller must know the size, width or length of the land, its surrounding environment, topography, and other features.
Advantages and Disadvantages of Hedonic Pricing
The major advantages of the hedonic pricing model include;
- It gives an estimate of the value of a good as determined by the characteristics of the item itself and external factors.
- Hedonic pricing uses real data and statistics when determining the prices of properties.
- This pricing method swiftly adapts to changes in external factors or characteristics of the item. It also estimates the degree to which ecosystems and environmental factors affect the prices of items.
Despite the benefits of the hedonic pricing method, it has its disadvantages which includes;
- Failure to capture the environmental preferences or differences of consumers and their willingness to pay, regardless of the differences.
- This pricing method does not consider the lack of awareness of consumers on certain factors that can affect their utility.
Hedonic pricing does not include eternal factors such as taxes, interest rates and other regulatory implications consumers might face and how they affect prices.
- Hedonic pricing accounts for the characteristics and factors that affect market prices, including external factors.
- This pricing model is often used in housing markets, it also estimates the extent to which environmental or ecosystem factors affect prices, especially the prices of homes.
- This pricing model accounts for factors such as scenic views, building appearance, fixtures, surrounding neighborhood, size and others in the pricing of a house or a piece of land.
- Hedonic pricing also reflects the willingness of consumers to pay for environmental differences or features of a home.
Example of Hedonic Pricing
As used in the housing markets, hedonic pricing considers the characteristics of a home and external features (such as environment or ecosystem) when assigning a price to a property. For instance, a house located in a neighborhood characterized by a high crime rate, water pollution, ad lack of access to civilization will be less expensive than a house situated in an urban region with a great scenic view, attractive environment, access to clean water and good road network. Another instance is a house close to parks or school environment and another located at a major road, while the former will be costlier, the latter will be cheaper because of their external attributes.