A house as a bundle of implicit prices

Yesterday’s post was about how the implicit price for neighborhood public goods, or what some people call amenities, like schools, parks, city services are a portion of the final sticker price of a home purchase. Buyers in the housing market consider square footage, beds, baths and the level of landscaping, but also make choices of financial consideration when comparing the infrastructure in the neighborhood and surrounding area. Just how long it will take to get to work or whether there are medical facilities close by are all contenders in the battle for the right bundle of components wrapped up in the final purchase.

The mathematical technique used to identify these bits of the final sales price, each dedicated to an amenity, is to solve for a hedonic equation. That is to line up a set of prices against data thought to be considered by consumers prior to purchase, and then solve. For instance, the violent crime rate is a very strong indicator in metering out a buyer’s sense of safety, and k-12 test scores are faithful representations of feelings around schools. When an econometrician equates prices to this data it is called running a regression.

Of course, there is much to this statistical process, and many mistakes can be made or avoided depending on how the problems are structured. But what I want to talk about is conceptionally what the coefficients, the numbers dictating the value (or maybe impact is a better word) of each amenity. It feels like a price since the unit of measure is dollars. For example, if a home in one school district were compared to the same home in more favorable district, the natural log of the coefficient gives the value as a percentage. In considering a purchase the buyer could say they would have to pay ten percent more for one home over the other. Or that there is a forty-thousand-dollar premium (on a 400K home) to purchase in the better district.

Sherwin Rosen who first wrote about this process in the ’70’s warned against thinking of implicit prices (the prices of the categories which make up a product) as an actual price since they come together as a bunch. In housing this is particularly true. One can’t make a wish list of features and tell a manufacturer to build it, like your latest laptop. One is not able to blend a prespecified structure and plunk it down just anywhere. For the most part consumers often bend on some desirable features in order to get others.

Buyers are also attracted to a variety of public goods at different times if their lives. Families with children in the home care about schools. Working stage of life folks need daily commuting infrastructure. Later stage in life people may want access to medical facilities. And it is these groups of people who are vying and competing for the homes which best offer the desired benefits.

Home economics is a study of bundled goods and grouped consumers.