The implicit market for quality: an hedonic analysis.

• Author: Thomas, Janet M.

which is for 1983. E is the percentage of consumers completing more than sixteen years of formal education. M is the percentage of consumers living in a different state in 1980 than in 1975. R is the percentage of consumers who are white. Income, y, is per capita money income in thousands of current dollars. Data for the housing value variable, h, are from the Statistical Abstract of the United States |43~, using state-specific 1980 median housing values in thousands of dollars. Territorial dummies are used to capture any regionally-specific differences in consumer preferences that are not directly measurable. For consistency, the territory definitions are coincident with those used to allocate the van I. Introduction

Modeling product differentiation has always presented a particular challenge to empirical researchers. The model must at once capture the complexity of output heterogeneity and remain within the bounds posed by econometric constraints. A fairly common approach employed in the literature is based on hedonic theory, which posits that a good or service is valued for its utility-bearing attributes |29~. Many empirical studies follow a pricing technique developed in part by Griliches |18~ to estimate marginal prices for a product's underlying characteristics |13; 14; 20; 34; 47~. More complex analyses estimate a structural implicit market model, using the procedure presented in Rosen's |36~ seminal work. This methodology is a two-stage process that uses estimated attribute prices derived from a first-stage hedonic price function to estimate a second-stage implicit market model for all product attributes. For example, Witte, Sumka, and Erekson |45~ use this approach to examine the supply and demand for housing attributes.

Recently, however, empirical research in hedonics has become the subject of much debate in the literature. Some of the contention deals with the proper functional form to be used for the hedonic price locus |6; 19; 35~. More serious discussion points out a "hidden" identification problem inherent in Rosen's |36~ two-stage empirical procedure |3; 4~. As a result, much of what had been achieved in advancing hedonic empirical work is now viewed in retrospect as suspect.(1) Clearly, new research is necessary to restore credibility to this important subject matter.

To that end, this research estimates an implicit market model using current methodology that directly addresses the empirical problems cited above. In particular, a multi-market estimation of an hedonic price locus is conducted to accommodate proper identification and estimation of a structural implicit model. Within this context, vertical product differentiation is studied, i.e., differentiation based solely upon the inherent quality of a good or service. An effective means to model product quality is demonstrated through a generalized index variable constructed to capture quality differences without compromising empirical tractability, a common problem associated with hedonic functions. That is, hedonic specifications, while theoretically pleasing, have limited applicability because of their tendency to become cumbersome as more attributes are added to the model. Conversely, a well-defined composite of product attributes economizes on the number of parameters to be estimated, providing a means to extend hedonic analysis to virtually any type of market environment.

The institutional setting for this study is the household goods motor carrier industry in the post-deregulatory period. It turns out that this particular market provides an interesting and policy-oriented context within which to test the model as well as to demonstrate the applicability of hedonic analysis. Prior to the industry's deregulation in 1980, the industry's service quality record had seriously declined. Proponents of deregulation believed that a more competitive environment would allow market forces to restore career performance to its equilibrium level.(2) This hypothesis is not unreasonable if in fact an implicit market for quality exists. The presence and nature of this assumed implicit market can be determined only through an hedonic analysis of the industry's service.

Presentation of this research begins in section II with a brief discussion of the industry environment and its relevance to this study. Section III presents the theoretical model for the hedonic price locus and the structural model as well as alternative specifications for modeling quality. Section IV gives the data sources, followed by section V, which presents the empirical model and an analysis of the results. Conclusions are provided in section VI.

2. Institutional Context

   The industry is defined for this study as the transportation activities of all Class I, II, and III interstate household goods carriers as classified by the Interstate Commerce Commission (ICC).(3) Despite the seeming similarity between this and other motor carrier industries, it is not structured, nor does it operate, in the same way as its more common counterpart, the general freight motor carrier industry. There are two characteristics of this market that best describe its unusual structure and make it a suitable and interesting environment within which to conduct the hedonic analysis. The first is that carrier performance in the provision of quality service is an integral part of the industry's operations and indeed its transition into a partially deregulated industry. The second is the presence of vertical relationships among some of the carriers, operationalized through van line-agency networks.

   Concern for product quality arises from the inherent vulnerability of consumers of moving services. It is difficult for consumers to make informed decisions in this market given that moving services possess primarily "experience" characteristics |33~. In addition, the typical consumer enters this market only infrequently. This combination of imperfect information and inexperience places the consumer at a direct disadvantage in dealing with suppliers |42~. To counter this imbalance, the ICC's Office of Compliance and Consumer Assistance collects and monitors various measures of career performance to be made available to prospective interstate shippers. Indeed, this commitment to performance was an important motivation behind the eventual deregulation of the industry in 1980. There is evidence to suggest that government-controlled tariff rates were held at depressed levels, impeding carriers' ability to provide the higher quality services presumably demanded by consumers |32~. Note that if the eventual deregulation policy was properly motivated, an implicit market for quality should exist in the post-1980 period, and a non-zero price for quality should result from the usual market forces.

   The presence of vertical relationships among carriers is not universal, suggesting a highly diverse operating structure at the firm level. The predominant structure is the van line system, a complex network of individual agents operating under the van line's ICC authorization. This cooperative arrangement evolved as a means to avoid cost-prohibitive, empty back hauls associated with the unpredictable routing of the industry. In the parlance of transportation economics, each system of agents defines the size of a van line's network or spatial market, where each agent represents a "node" in that network. Interestingly, despite evidence that cost economies are associated with larger networks |5; 8~, many carriers operate independently, exploiting neither these economic advantages nor the national reputation of a large van line. This operational diversity is important to the implicit market specification, since the van line's reputation and size are expected to influence consumer demand for quality. In addition, network size and other operating characteristics are used to control for the inherent heterogeneity of motor carrier services not associated with quality.

3. Theoretical Model

   The basic structure of the theoretical model follows Rosen |36~ by defining an implicit market as a plane of several dimensions on which consumers and producers locate. In this context, each dimension represents a specific quality attribute of the differentiated moving service measured such that each has a positive marginal value. Any point on the plane is defined by a vector, z = (|z.sub.1~, |z.sub.2~, . . . |z.sub.n~), where each |z.sub.i~ represents the amount of the ith quality attribute associated with a particular carrier's service. The locational decisions of buyers and sellers are the result of optimizing behavior that is in turn motivated by the market price of output associated with each z vector, P(z).

   According to Rosen, the consumer's utility-maximizing decision gives rise to a value or bid function that defines the consumer's willingness to pay for varying values of z at a fixed utility level and a given income level. In this study, each bid function, |Theta~, distinguished by taste differences, is specified as follows:(4)

   |Theta~ = |Theta~|(z, y, |Alpha~).sup.5~, (1)

   where:

   |Theta~ is assumed increasing in the |z.sub.i~ at a decreasing rate,

   y is consumer income,

   |Alpha~ is a vector of consumer characteristics capturing differences in tastes or preferences, and

   ||Theta~.sub.zi~ = |Delta~|Theta~/|Delta~|z.sub.i~ is the implicit marginal valuation or bid price the consumer assigns to |z.sub.i~.

   Since |Theta~ is the consumer's reservation price for z, and since P(z) is the minimum market price the consumer must pay for that z configuration, the geometric representation of utility maximization occurs where the two surfaces defined by |Theta~(z, y, |Alpha~) and p(z) are tangent. Thus, Rosen defines consumer equilibrium as a family of bid functions whose envelope is the hedonic or implicit price function. Algebraically, this occurs when each |z.sub.i~ is at its optimal level, |z*.sub.i~, such that |Delta~|Theta~/|Delta~|z.sub.i~ =...