Hedonic pricing

As the first Focus box in this chapter explains, it is difficult to measure the true increase in prices of goods whose characteristics change over time. For such goods, part of any price increase can be attributed to an increase in quality. Hedonic pricing offers a method to compute the quality-adjusted increase in prices.

a. Consider the case of a routine medical checkup. Name some reasons you might want to use hedonic pricing to measure the change in the price of this service.

Now consider the case of a medical checkup for a pregnant woman. Suppose that a new ultrasound method is introduced. In the first year that this method is available, half of doctors offer the new method, and half offer the old method. A checkup using the new method costs 10% more than a checkup using the old method.

b. In percentage terms, how much of a quality increase does the new method represent over the old method? (Hint: Consider the fact that some women choose to see a doctor offering the new method when they could have chosen to see a doctor offering the old method.)
Now, in addition, suppose that in the first year the new ultra- sound method is available, the price of checkups using the new method is 15% higher than the price of checkups in the previous year (when everyone used the old method).

c. How much of the higher price for checkups using the new method (as compared to checkups in the previous year) re- flects a true price increase of checkups and how much repre- sents a quality increase? In other words, how much higher is the quality-adjusted price of checkups using the new method as compared to the price of checkups in the previous year?

In many cases, the kind of information we used in parts (b) and(c) is not available. For example, suppose that in the year the new ultrasound method is introduced, all doctors adopt the new method, so the old method is no longer used. In addition, continue to assume that the price of checkups in the year the new method is introduced is 15% higher than the price of check- ups in the previous year (when everyone used the old method). Thus, we observe a 15% price increase in checkups, but we real- ize that the quality of checkups has increased.

d. Under these assumptions, what information required to compute the quality-adjusted price increase of checkups is lacking? Even without this information, can we say any- thing about the quality-adjusted price increase of check- ups? Is it more than 15%? less than 15%? Explain.