Hedonic pricing is an economic term used to describe a pricing system or model where the price of an item is not limited to the direct worth of the item itself. Rather, under this type of system, the external and internal factors surrounding the item under consideration contribute to the sum total, or final price or value, of such an item. This type of model is more often used, but not restricted, to the housing or real estate market as well as in the area of labor.
The application of hedonic pricing in real estate is used to determine the exact worth of a house. This is because many external and internal considerations are considered when trying to arrive at a final estimate for such property. Considerations on the property price would take into account the size of the house, the number of rooms in the house, the size of those rooms, the quality of the building materials, the style of the building, and other features like the size and capacity of the garage and the existence of a garden or lawn. All of these considerations are part of the internal analysis of the worth of the house on its own without any other added consideration.
Under the hedonic pricing scale, this would not be the only parameter for the determination of the value of the property. External factors would also be considered in addition to the value of the house itself before a final estimate can be reached. The external factors that are part of the hedonic pricing for this particular item include the location of the house, the neighborhood, the proximity of the property to amenities like markets, schools and subways, and environmental factors. Another aspect in the hedonic pricing for this item would be the value of the external features to the buyer. Someone who specifies that the property must be located no more than a mile from a subway may have contributed to the hedonic pricing of the house due to this indication, which will increase the value of the house to that particular customer.
In the labor market, the application of hedonic pricing is apparent in terms of its use in determining wages. A worker might be transferred to another country that is considered less developed than the employee's country of origin. In such a case, the external factors like lack of amenities and the attendant inconvenience will serve to push the wages of the worker up as a sort of compensation for the hassle, even if the position is the same as the previous one.