Question: Hedonic Modeling
Assume we have two identical houses. Each house is a 3 bedroom, 3 bath, 2000 square feetwhite house on a 1 acre lot and both were built in 1996. The single difference is that house B islocated near a hazardous waste site and house A is not.
a) If both homes are listed for sale at a price of $200,000, carefully explain what willhappen to the prices of these houses before the market reaches equilibrium.
b) Which house is now more expensive? Why?
c) What does the difference in the value of the houses represent?
d) Explain the concept of compensating differentials in terms of the propertytransactions described above.