1 / 24

Valuation 10: Hedonic Pricing

Valuation 10: Hedonic Pricing. A partial equilibrium model of prices, wages and pollution The hedonic price equation From hedonic prices to welfare Application: Environmental hazards. Last two weeks we looked at.

antoinette
Download Presentation

Valuation 10: Hedonic Pricing

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Valuation 10: Hedonic Pricing • A partial equilibrium model of prices, wages and pollution • The hedonic price equation • From hedonic prices to welfare • Application: Environmental hazards

  2. Last two weeks we looked at • The household production function approach, which assumes that certain observable behaviour is a complement (e.g., travel to recreate) or substitute (e.g., airbag for road safety) to unobservable consumption of an environmental good or service • A simple travel cost model of a single site • Multiple sites • Implementation • The zonal travel cost method • The individual travel cost model • Travel cost with a random utility model

  3. The price of land • The asset price equals the value of the stream of services that the parcel can be expected to provide in the future, netted back to the present • uncertainty about the future • The rental price of land is the value of renting for a short period • e.g., for agricultural land, the difference between expected yield times prices minus the costs of labour, seeds, pesticides etc • expectations about the future play little or no role • Pollution degrades value and thus price • What is the WTP to clean up the pollution?

  4. Starters • What is the WTP to clean up pollution? • Consider agricultural land in a valley, half of which is upwind a polluting plant, the other half downwind • If this is a small valley with a local market for agricultural goods the land value change will not fully capture the value for cleaner air • If this is a small valley in a large market the difference between land value is a proxy of the value of pollution • Consider an open city, with free mobility • Utility must be the same everywhere • So land prices exactly compensate for pollution • In a closed city, reducing non-uniform pollution would affect property values as well as utility

  5. Wages, land prices and pollution • Arguably, pollution should suppress land prices – but we see that urban land is worth more than rural land • Urban wages are also higher than rural wages – do wages rise to compensate for deteriorating environmental quality? • We will construct a model of urban land prices, wages and pollution -- first, analytically and then we‘ll derive a function that can be estimated

  6. The consumer • Consider a number of cities that have different levels of pollution p; firms produce a composite good X (at price 1) and move about freely; the wage rate w and the land rent r vary between cities • Consumers are identical, purchase X and land for housing L • Each consumer has the utility maximization problem: • The utility level for a particular set of w, r and p is • Assuming free movement, utility is the same everywhere

  7. The producer • In a constant cost industry, the average cost of producing X equals the product price which is the same for all cities • The price for the product is the same, but the composition of inputs can differ • If rents are higher in one city, wages must be lower to compensate, otherwise the firm would relocate • Pollution may affect costs in different ways • Unproductive (pollution hinders production) • Productive (pollution regulation hinders production) • Neutral (no affect on the firm, but wages and rents affect production)

  8. Productive and unproductive pollution Two cities with different pollution levels: p2> p1 • Cases A and B: when pollution is productive wages rise • Cases C and D: when pollution is unproductive land prices decrease r c(w,r,p2)=1 c(w,r,p1)=1 V(w,r,p1)=k V(w,r,p2)=k C A B D w

  9. Sum up • Because the utility levels of the citizens must be the same, higher pollution must be compensated by either higher wages, lower land rents or both • If pollution is productive, the firm spends less on pollution control • To keep costs constant for higher levels of pollution, wages or land prices must rise • Putting consumers and producers together • If pollution is productive, pollution raises wages but has an ambiguous effect on land rents • If pollution is unproductive, pollution depresses land prices but has an ambiguous effect on wages • If pollution is neutral, pollution decreases land prices and increases wages

  10. Hedonic price theory • In the “real world” we are often confronted with bundles of goods with a single price for the whole bundle • We are interested in the price of an element of the bundle • This is the focus of the hedonic price theory • By observing the prices of many houses with different characteristics, we can infer the implicit value that is being placed on one characteristic, e.g. air quality • By observing wages associated with many different occupations we can infer the value of small changes in e.g. risk • Applied to prices of farmland as early as 1922 • Rosen (1974) developed the formal theory of hedonic prices

  11. Hedonic price theory (2) • Consider an homogenous area that can be considered a single market from the point of view of, say, houses • For simplification, each house is characterised by a single characteristic, z, say, air pollution • We are interested in the relation between price and air quality, p = p(z) • The price function is an equilibrium concept (partial equilibrium) resulting from interaction of supply and demand • We assume that the market is perfect • Both producers and consumers take p(z) as given

  12. The consumer • The consumer buys one house as well as other goods x • The consumer’s problem is: • What is the amount of x for particular values of z to achieve a certain level of utility: • The budget for buying the house, guaranteeing a certain level of utility is • Alternatively, we can define the consumer’s problem as • This is known as the bid function – it tells you the maximum amount a consumer is willing to pay as a function of income and air pollution

  13. Consumer choice • Hedonic price function and two bid functions for two different levels of utility $ p(z) Q(y,z,U0) Q(y,z,U1) Utility increases Air quality z

  14. The producer • The costs c of producing one house depend on input prices r and the characteristics z: c(r,z) • The producer maximises profits • Alternatively the price to obtain a certain level of profit given a level of z is • This is known as the offer function – it tells you the minimum amount a producer is willing to accept as a function of costs and air pollution

  15. Producer choice • Hedonic price function and two offer functions for two different levels of profit $ F(r,z, p2) Profits increase F(r,z, p1) p(z) Air quality z

  16. Market equilibrium In the equilibrium, the marginal bid, the marginal offer, and the house price are identical – all parties in the market value the house the same, at the margin p(z) $ F3 Q3 F2 Q2 F1 Q1 Air quality z

  17. Willingness to pay $/unit Marginal implicit price function and marginal WTP for one more unit of z for consumers 1 and 2 MWTP2(z) MWTP1(z) p‘(z) Air quality z

  18. Sum up • The hedonic price function tells you how price varies with environmental quality and other factors (income) • Take the derivative of the rental price to environmental quality – this gives the price of environmental quality • This is the first-stage estimation procedure • Do this for various income levels • This gives the price of environmental quality as a function of income – that is, an inverse demand function • This is the second-stage estimation procedure • This assumes, that different individuals making choices along the hedonic price function are variants of the same person • As the second-stage estimation procedure uses no additional data beyond the already contained in the hedonic price function, it can only reproduce the coefficients estimated from the hedonic price function • Recent applications of the method estimate only the first-stage

  19. Theory and practice • Theory and practice differ substantially • Niceties such as the difference between compensated and uncompensated demand functions are typically ignored • Critical assumptions: • Households have full information on all housing prices and attributes, transaction and moving costs are zero • Prices adjust instantaneously to changes • Market distortions are ignored • Only one market (housing) is analysed • The reason: data; although wages and house prices are known, it is hard to get data because of privacy

  20. Application: Environmental hazards • Do environmental hazards such as the proximity to a major fuel pipeline affect house prices? • Study by Hansen, Benson and Hagen (Land Economics, 2006) • They use data for Bellingham, Washington, • the site of a 1999 rupture and explosion and compare housing prices before and after the accident (1995-2004) • The results suggest that the event led to a significant increase in perceived risk and perhaps to an increase beyond the actual risk • Before the accident public awareness was low and risks were irrelevant indicating a deviation between perceived and actual risk

  21. Data and modelling strategy • In Bellingham, two major transmission pipelines run through residential area • The Olympic pipeline (refined petroleum) and the Trans Mountain pipeline (crude oil) • On June 10, 1999, the Olympic pipeline ruptured, spilling 229000 gallons of gasoline into the Whatcom Creek • Sales of all houses located within one mile of either pipeline was sampled for the period 1995 to 2004 • A number of housing characteristics were included as well as the distance to a pipeline • To test the hypothesis (sales price are not affected in the absence of an effect) they split the sample to estimate the model for each sub-sample, the pre-event and the post-event sample

  22. Regression results * Significant at the 1% level; ** significant at the 5% level; *** significant at the 10% level.

  23. As distance increases, sales price rises to the average level

  24. The effect decays over time, but a significant price effect remains

More Related