A negative externality is defined as a by-product of production or consumption activities that adversely affects third parties not directly involved in the associated market transactions. Noise from aircraft and road traffic is an example of an uncompensated external cost or externality. Section 1.5 offers concluding statements. We also review alternative methods of recovering demand parameters including random utility models and locational equilibrium models. We review the method and recent research which indicates the promise of the method has yet to be fully exploited.

In the thirty years since Rosen’s first proposed this two-stage approach, much has been written about its potential and its limitations. Rosen (1974) described a two-step procedure in which implicit prices for housing characteristics recovered in the first stage analysis could be combined with observed quantities of characteristics chosen to estimate underlying demands for characteristics. While most hedonic analyses only estimate a first stage hedonic price function, information from this first stage analysis may be used to complete a second stage analysis in which the underlying preferences for housing characteristics are estimated. In this chapter, we review the hedonic model as developed by Rosen as well as recent theoretical and empirical developments in hedonic modeling. As such, observed choices over housing reveals to the researcher information about the underlying preferences for these amenities or other characteristics of interest.

Housing choice not only confers to the owner/renter consumption of property and structural housing characteristics, but consumption of all location characteristics of the property such as proximity to environmental amenities and disamenities. Although hedonic analyses have been reported as far back as Waugh’s (1928) analysis of agricultural markets, it was Rosen’s (1974) seminal work that began a rich theoretical and empirical literature exploring the role of housing attributes in consumer decision making.

Hedonic method