Understanding economics

Sometimes I tend to ask myself some strange questions (strange for most people, not for me). One of them goes around the question of price (see there and there). I am most intrigued by how prices are made.

Sure every price depends on how much was needed to make the tea you are drinking with a chain of middlemen bringing it from the garden it was harvested to your cup. And every one of these people has its own costs and wants to make a living out of it. Then there is the price the customer is ready to pay based on the reputation of the tea, on the reputation of the company he is buying it from, on … But is there a way to do that? The answer is that there is always a way in economics (otherwise, it wouldn’t be fun) and it is called hedonic regression or hedonic demand theory.

Now you are probably looking at a dictionary trying to figure out what I might be talking about. And my guess is that you found the definition of hedonism but guess what? Things are well done and hedonism and the hedonic demand theory have something in common.

Hedonism is a school of thought that focuses on maximising net pleasure (pleasure minus pain) in everything. Following that, there is a whole different bunch of people and schools making some variations (more or less important) to this basis. The most famous being the Epicureanism, which is usually summed up by indulging in pleasure without any retinue, which is a misunderstanding while for true epicureans, the goal is to reach tranquillity and absence of pain.

But enough philosophy and let’s get back on topic and tea (although some might find that a tea well done is a way of following the steps of this school of thought but I won’t go any further alongside this road).

The hedonic demand theory builds on that and on the idea that you can divide everything in constituent characteristics and therefore get estimates of the value of each smaller part in the overall price. This is done for real estate economics (among other things) where a good/house is made of different attributes (number of bedrooms, distance to the city centre, size of the land…), for each one which a price or an elasticity (the way one variable responds when another one changes, for example when price go up or down) are looked after. Once the information is compiled, it can be used to compare prices or to create a price index and compare the evolution over time.

You are probably going to wonder where this will lead us but you will have to wait a little more. While I was browsing on the topic of tea and this hedonic price function, I stumbled upon an article upon something that is not tea but that is more akin to it than the real estate economics: wines from Champagne. I found out that in 1998, someone analysed and published such an analysis (for the complete reference: Gergaud Olivier. Estimation d’une fonction de prix hédonistiques pour le vin de Champagne. In: Économie & prévision, n°136, 1998-5. pp. 93-105, http://www.persee.fr/doc/ecop_0249-4744_1998_num_136_5_5940). What I found in here was something that I think can be used for tea too, a complete method about how to gather data and calculate everything to find out whether or not such a function could be made for tea and lastly a kind of value-for-money equation.

From what I read, it will be quite a challenge both for the gathering of data and the mathematical skills behind it.

I also think that like for the wines of Champagne, a choice will have to be made regarding a peculiar geographical area and type of tea (I think that flavoured teas are out of the scope of such an analysis). Even with such a smaller area, the gathering of prices and the qualitative analysis over “long” periods of time will be a difficulty. By long, I mean the longest possible as with everything in data, the longer the period of observation, the better the interpretation and thus the capacity to find correlation, function and so on.

What do you think? Is there an interest in such an analysis? Would it be worth the time investment?

And my title? It is a quote by an American economist and economics professor. The full quote is Economics is everywhere, and understanding economics can help you make better decisions and lead a happier life. Something I find well in line with the ideas of hedonism.

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