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Hedonic Prices and Implicit Markets: Product Differentiation Competition Sherwin Rosen The Journal of Political Economy, Volume 82, Issue 1 (Jan. - Feb., 1974), 34-55. Stable URL: hhup:/links jstor.org/sici?sici -3808%28197401%2F197402%2982%3 1%3C34%3AHPAIMPS3E2,0,CO%3B2-U ‘Your use of the ISTOR archive indicates your acceptance of ISTOR’s Terms and Conditions of Use, available at hup:/hwww stor org/aboutiterms.himl. ISTOR’s Terms and Conditions of Use provides, in part, that unless you have oblained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and ‘you may use content in the JSTOR archive only for your personal, non-commercial us. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the sereen or printed page of such transmission, ‘The Joumnat of Political Economy is published by The University of Chicago Press. Please contact the publisher for further permissions regarding the use of this work, Publisher contact information may be obtained at -up:/wwwwjstor.org/journals/uepress.huml, ‘The Jounal of Political Economy (©1974 The University of Chicago Press JSTOR and the JSTOR logo are trademarks of JSTOR, and are Registered in the U.S. Patent and Trademark Office. For more information on JSTOR contact jstor-info@umich edu, ©2002 JSTOR hupulwww jstororg/ ‘Sun Oet 27 09:54:03 2002 Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition Sherwin Rosen University of Rachser and Harvard Univesity A class of dferentiated products is completely described by a vector of ‘objectively measured characteristics. Observed product prices and the specific amounts of characteristics associated with each good define a set cof implicit or “hedonic” prices. A theory of hedonic prices is formulated asa problem in the economics of spatial equilibrium in which the entire set of implicit prices guides both consumer and producer locational decisions in characteristics space. Buyer and seller choices as well as the meaning and nature of market equilibrium, are analyced. Empirical implications for hedonic price regressions and index number con- struction are pointed out. I. Introduction and Summary ‘This paper sketches a model of product differentiation based on the hedonic hypothesis that goods are valued for their utility-bearing attrib- utes or characteristics. Hedonic prices are defined as the implicit prices of attributes and are revealed to economic agents from observed prices of differentiated products and the specific amounts of characteristics asso- ciated with them. They constitute the empirical magnitudes explained by the model. Econometrically, implicit prices are estimated by the first- step regression analysis (product price regressed on characteristics) in the construction of hedonic price indexes. With few exceptions, structural ‘The substance of this paper arose feom conversations with H. Gregg Lewis several years ‘ago. A muluitude of other people have conteibuted advice and criticism. Among them are William Brock, Stanley Engerman, Robert J. Gordan, Zvi Grlics, Robert E. Lucas, Jr Michael Mussa, and the referee. Rermaining errors are my own responsibilty, Financial support trom the Genter for Naval Analysis and the National Institute of Education is tratefully acknowledged HEDONIC PRICES a interpretations of the hedonic method are not available." Therefore, our primary goal is to exhibit a generating mechanism for the observations in the competitive case and to use that structure to clarify the meaning and interpretation of estimated implicit prices. It will be shown that these {data generally contain less information than is commonly supposed. How- ever, the model suggests a method that often can identify the underlying structural parameters of interest. Also, as a general methodological point, is demonstrated that conceptualizing the problem of product differen- tiation in terms ofa few underlying characteristics instead of a large num- ber of closely related generic goods leads to an analysis having much in common with the economics of spatial equilibrium and the theory of equalizing differences. "The model itself amounts to a description of competitive equilibrium in a plane of several dimensions on which both buyers and sellers locate. ‘The class of goods under consideration is described by n objectively mea- sured characteristics. Thus, any location on the plane, is represented by a vector of coordinates z= (24, 23,-++) Z4)» with z, measuring the amount of the ith characteristic contained in each good. Products in the class are completely described by numerical values of z and offer buyers distinct packages of characteristics. Furthermore, existence of product

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