Business enterprises use different methods to put prices on their products. One of these methods involves hedonic pricing. Hedonic pricing refers to the identification of price factors, according to the belief that price determination depends on internal characteristics of the goods sold, and the external factors that affect the good. This paper identifies hedonic method of pricing and the reason for its use in tracking changes, in the consumer price index.
The hedonic pricing method estimates economic values for an ecosystem that provides services that directly affect market prices. People use the method mostly, in housing where prices vary with local environmental attributes. Business organizations can also use the method to determine economic benefits or costs that come with environmental qualities such as air pollution, noise and water pollution. It also includes environmental amenities, such as proximity to recreational sites (Triplett, 2006).
The use of the method bases on the fact that people consider the characteristics of a product and the help it provides other than the product itself. The prices reflect the characteristics that people consider before purchasing any product. The method works in a straightforward way because it works with actual market prices and the measured data.
The purpose of a consumer price index involves measuring the influences of price transformation on consumer households. In a cost of living index, substitution behavior in response to price changes incorporated. The index compares price regimes with respect to a fixed reference level of satisfaction (Triplett, 2006).
The empirical hedonic analysis provides meaningful information that infers the value that consumers put on quality changes and estimates from hedonic regressions, which can determine the adjustments on price indices. Firstly, one can identify a product that fades away from the market, and select a substitute that results in adjustments to the price of one or the other item, to make them comparable statistically, in terms of quality. In such a method, one can multiply the hedonically derived implicit price of an attribute by the difference and the level of the attribute between the old and the new product.
Another method would involve imputing the price of an item in a period before it enters the market. It uses hedonic coefficients and observed characteristics of the product. It imputes a reservation price for the product that has appeared, in the market for the first time. Alternatively, one could use a direct way, where one estimates an adjusted price index directly from hedonic coefficients and the attributes of the product sold. The coefficients in the dummies form price differences between the periods specified and the period of references of net changes in the quality of characteristics of products available at any time. In practice, the use of the direct method relies on samples taken from different periods. Therefore, it becomes unclear how the characteristics implicit values and the regression coefficients. This may change over time, as the whole market evolves, bringing in new types of goods (Triplett, 2006).
In context of quality adjustment of price indices, the stability of hedonic coefficients over time has become a concern. Hedonic regressions estimate on a cross-section model, and capture a blueprint of the market at certain periods. Hedonic method on price setting tracks changes in consumer price index because of the various ways it employs. It uses both the direct and indirect ways.
Hedonic ways of pricing have proved advantageous. Business enterprises utilize the method to determine the prices of goods and predict the price of new products that they intend to introduce to market because the method can track changes in prices of all goods and services, in the market.