Quality -adjusted prices: Theory, history, and application to air quality

Economists have long used non-market valuation techniques in policy analysis, but the application of these approaches to "green" national accounts and price indices has not been explored. This research uses such techniques to incorporate the environment and other public goods into a cost-of-living index.;The starting point is the insight that when public goods are linked to a marketed good as a weak complement, quality-adjusted prices for the marketed good can capture all the welfare information needed for the index. The dissertation then links this relationship to the information obtained from hedonic regressions and discrete choice models. For the case of discrete choice models, aggregation over household-level "expected cost-of-living indices" is analogous to more familiar indices.;These concepts are then applied to the case of housing, air quality, and other public goods in Los Angeles. Using a large data set of actual housing transactions, quality-adjusted housing price indices are estimated for 1989 to 1994. These sub-indices are entered into the Laspeyres index to derive an over-all index that incorporates public goods. Because air quality has improved over time in Los Angeles, the housing index with public goods is about 0.4 to 0.7 percentage points lower than the index omitting public goods, depending on the model used. These differences imply an over all effect on estimated inflation in Los Angeles of 0.1 to 0.2 percentage points.;A concluding chapter explores the history of quality-adjusted price indices from 1915 to 1965. The history focuses on external reviews conducted by Wesley Clair Mitchell in 1915, an NBER committee chaired by Mitchell during World War II, and an NBER committee chaired by George Stigler in 1961. Approaches to quality adjustment at each of these times is conditioned by the contemporary understanding of the purposes of a price index. An additional theme emerges that modern quality adjustments using hedonic models have a parallel in earlier treatments.