Price Indexes (8) Hedonic Methods

Direct Adjustments for quality change are difficult to make without introducing subjectivity or bias. Consider an example. If the only difference between the old and the new car is a catalytic converter, a direct assessment of its value to consumers must be made.

Most information about the cost and perceived value of the catalytic converter will come from the manufacturer, who is likely to have a biased view. This is why statisticians prefer not to make direct adjustments. Contrary to popular opinion, hedonic adjustment has been introduced to make direct quality assessments more objective.

To apply the hedonic method, index statisticians collect the prices of as many cars as possible that are available with and without catalytic converters. A regression is then used to calculate how much difference the addition of a catalytic converter makes to a car.

In principle, the hedonic method is more objective than direct adjustment, because information from the market place is used to estimate the value of a so-called quality improvement. Using information from the market will generally be better than depending on the judgments of statisticians and information from suppliers. For example, critics often argue that statisticians place too higher value on things like extra memory on a computer.

The hedonic method deals with this issue by attempting to use market prices to assess how much consumers are willing to pay for extra memory. If extra memory is of no value to consumers, this should be reflected in the hedonic measure. This should be better than a subjective “direct assessment” by a statistician.