What is hedonic pricing method?

Hedonic pricing is a method of price identification based on a particular premise - price is determined based on external factors affecting the good as well as internal gestures of the good being offered. The key objective of the hedonic pricing method is to estimate quantitative values for various environmental services directly impacting housing market prices. The technique often depends on statistical expertise along with model specification.

In short, the hedonic pricing method, also known as hedonic demand theory or hedonic regression, explores the degree to which every external and internal factor affects the property’s price. When determining hedonic prices, both environmental and non-environmental aspects are considered.

Hedonic pricing method is pretty straightforward, especially when it comes to valuing properties. It relies on market prices and accessible data sets. Essential, hedonic price depends on the data a company gathers and analyzes.

The Hedonic model is associated with real-estate appraisal, namely because there are a variety of ease-to-measure factors. When considering such characteristics, it is possible to change the price or further change the traits to boost the price. The simplicity of the model is its primary strength. That’s why the hedonic model is used across various industries, including retail.

Hedonic pricing method in environmental economics

As was mentioned above, hedonic regression is most commonly applied in real estate economics. However, experts can also use it in environmental economics and engage in consumer price index (CPI) calculations. One should keep in mind that price changes because of various substitution effects in the hedonic pricing method.

In environmental economics, hedonic price is determined by estimating how different environmental and ecosystem aspects affect the selected price. In such a case, for environmental economics, one can explore the scenario consisting of four variables:

Situation. There is a property in a coastline region. It is a rural area with massive farmland. Yet, there is a rapidly growing town nearby, which results in development pressures on the farmland.
Challenge. With the growing population in the town, there is a different valuation of properties and open spaces nearby. It is the moment when hedonic valuation is conducted.
Analysis. In such a case, hedonic regression in environmental economics dictates considering factors like open scape, zoning, farmland, and roads to determine the hedonic price of any property in the area.
Outcome. Based on the analysis results, the hedonic regression in environmental economics allows determining the potential price for the properties in question.

The scenario illustrates how the hedonic pricing method can be applied in environmental economics. Essentially, the approach determines the hedonic price in a particular area while considering environmental factors at hand.

The hedonic pricing model for housing

In the real-estate business and the housing market in general, hedonic price is determined by several key factors. Namely, the price of a property or land depends on the features of both the property, for instance, size and condition, and the surrounding environment, for example, the crime rate of the area and air pollution.

When applying the hedonic pricing method to the housing market, several important aspects are to consider. First and foremost, it is crucial to view an index of the environmental amenity of interest. Second, companies must take into account cross-section and time-series data on property values.

The data is analyzed with regression analysis within the hedonic price application model. In such a case, the correlation depends on the inclusion of the property’s price linked to its non-environmental and environmental traits. Companies can estimate the impact of the characteristics mentioned earlier on the price itself by keeping all the things together.

One should keep in mind that applying hedonic regression to determine hedonic price can be challenging in housing. The connection between the property’s worth and internal and external characteristics might not be linear. It means that prices can increase and decrease at different rates when various features change. Besides, the hedonic price can be hard to estimate if there is insufficient data to conduct regression analysis.

Hedonic pricing model formula

Hedonic pricing method formula depends on two steps:

The first step relies on determining the link between the property’s or land’s value, which is a dependent variable. The further inclination into the step depends on the determination of independent variables, which correlate to the property’s or land’s internal and external features.
The second step of the hedonic regression formula includes the analysis of the client’s willingness to pay for a particular asset based on the prospective income and preferences. The degree of readiness is determined based on the property's internal and client characteristics.

When following these steps, one can determine the hedonic price. Essentially, it would be a price variation in connection to changes in the property’s internal and external characteristics. The hedonic pricing method can be perceived as the evaluation of the additional cost of the property or land, namely because of any additional benefit that can be derived from its internal or external feature.

The hedonic pricing formula depends on both dependent and independent variables. Establishing them makes it possible to properly assess the hedonic price and estimate any additional benefits one can derive from it.

Concluding remarks

The hedonic pricing method is straightforward and easy way to determine additional cost of the property or land when considering a range of internal and external factors. Besides, its formula includes the client’s willingness to pay to estimate any additional profit one can have from the given property or land.

FAQ

Find answers to some of the most common questions people have regarding the use of Competera.

What are the benefits of hedonic pricing?

You can benefit from the hedonic pricing model as it is flexible and adjustable to other market products and external factors. Besides, you can estimate the cost aligned with concrete choices.

What industries mainly use the hedonic pricing model?

The property market frequently applies the hedonic pricing model. Real estate prices include not only characteristics of the property itself but also the location (environment, neighborhood, etc.).