The Implicit Market for Quality: An Hedonic Analysis

Abstract

Modeling product differentiation has always presented a particular challenge to empirical researchers. The model must at once capture the complexity of output heterogeneity and remain within the bounds posed by econometric constraints. A fairly common approach employed in the literature is based on hedonic theory, which posits that a good or service is valued for its utilitybearing attributes [29]. Many empirical studies follow a pricing technique developed in part by Griliches [18] to estimate marginal prices for a product's underlying characteristics [13; 14; 20; 34; 47]. More complex analyses estimate a structural implicit market model, using the procedure presented in Rosen's [36] seminal work. This methodology is a two-stage process that uses estimated attribute prices derived from a first-stage hedonic price function to estimate a second-stage implicit market model for all product attributes. For example, Witte, Sumka, and Erekson [45] use this approach to examine the supply and demand for housing attributes. Recently, however, empirical research in hedonics has become the subject of much debate in the literature. Some of the contention deals with the proper functional form to be used for the hedonic price locus [6; 19; 35]. More serious discussion points out a hidden identification problem inherent in Rosen's [36] two-stage empirical procedure [3; 4]. As a result, much of what had been achieved in advancing hedonic empirical work is now viewed in retrospect as suspect.' Clearly, new research is necessary to restore credibility to this important subject matter. To that end, this research estimates an implicit market model using current methodology that directly addresses the empirical problems cited above. In particular, a multi-market estimation of an hedonic price locus is conducted to accommodate proper identification and estimation of a structural implicit model. Within this context, vertical product differentiation is studied, i.e., differentiation based solely upon the inherent quality of a good or service. An effective means to model product quality is demonstrated through a generalized index variable constructed to capture quality differences without compromising empirical tractability, a common problem associated