1. It is difficult to measure the true increase in prices of goods whose characteristics change over time. For such goods, part of any price increase can be attributed to an increase in quality. Hedonic pricing offers a method to compute the quality-adjusted increase in prices.
Consider a case of a routine medical checkup for a pregnant woman. Suppose that a new ultrasound method is introduced. A checkup using the new method costs 10% more than a checkup using the old method.
Suppose that in the first year the new ultrasound method is available, half of doctors offer the new method, and half offer the old method. In addition, suppose that the price of checkups using the new method is 15% higher than the price of checkups using the old method (which is the same as the price of checkups in the previous year when everyone used the old method). How much of the higher price for checkups in this year represents a true price increase and how much represents a quality increase?
Suppose instead, that in the first year new ultrasound method is available, all doctors adopt the new method and the old method is no longer in use. Continue to assume that the price of checkups using the new method is 15% higher than the price of checkups in the previous year Then in this case, how much of the higher price for checkups in this year represents a price increase and how much represents a quality increase? Explain whether your calculation in this case is an over- or under-estimation of the true price increase.