Behind the Hedonic Pricing Fallacy, a Misunderstanding of Money

Following up on a previous post here, an over-simplified example may help demonstrate that hedonic pricing adjustments for quality increases in goods are not compatible with a proper understanding of money and prices.

Assume that money can only buy one thing. In particular, for $20 you can rent a Yugo sedan for a four hour summer drive in the country. With this European import, the air conditioning option consists of the rental agent knocking out all of the side windows.

Also assume that you have a total of $40 dollars. On what basis do you decide whether or not to spend 20 of those dollars for a Yugo rental this afternoon?

Every decision as to whether purchase a good rests on a subjective comparison between the satisfaction that the good provides in the present and the future satisfaction that the money needed for its purchase could be expected to alternately provide in the purchase of future goods, discounted back to the present by a rate of time preference of present satisfactions over future satisfactions. The inherent uncertainty of the future is also a factor that adds to the desire to hold money in preference to spending it all.

In this over-simplified example, the choice boils down to a drive in the country today and one in the future versus two drives in the future, assuming no changes in conditions occur.

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