THEORY OF THE HEDONIC APPROACH TO PRODUCER GOODS

Abstract

This paper tries to answer the following question: Why can we obtain quality-adjusted price indexes of producer goods by regressing their prices on their characteristics? In other words, what are measured by the hedonic approach?
Two models are presented. One is based on Lancastrian approach to consumer theory. The other is based on Adelman-Griliches and Fish-Shell models. Section 2 uses Lancastrian approach. It derives a hedonic equation and presents two versions of hedonic price index; (a) ratio of marginal costs at two points of time and (b) market basket type definitions. Generally, hedonic indexes are not equal to the theoretical definition of producer goods' price indexes. The cases are shown where both coincide. Section 3 presents a model based on Adelman-Griliches and Fisher-Shell. Again, hedonic price indexes are not generally equal to the theoretical definition of the index. Generally, the hedonic index of a particular good depends on the quantities of all goods. Hedonic indexes are equal to the theoretical definition and do not depend on the quantity of any good under the“pure repackaging”hypothesis.