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Why Do Payment Card Networks Charge Proportional Fees?

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  • Oz Shy
  • Zhu Wang

Abstract

This paper explains why payment card networks charge fees that are proportional to the transaction values instead of charging fixed per-transaction fees. We show that, when card networks and merchants both have market power, card networks earn higher profits by charging proportional fees. It is also shown that competition among merchants reduces card networks' gains from using proportional fees relative to fixed per-transaction fees. Merchants are found to earn lower profits under proportional fees, whereas consumer utility and social welfare are higher. Our welfare results are then evaluated with respect to the current regulatory policy debates. (JEL E42, G21, G28)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.101.4.1575
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 101 (2011)
Issue (Month): 4 (June)
Pages: 1575-90

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Handle: RePEc:aea:aecrev:v:101:y:2011:i:4:p:1575-90

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References

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  1. Schwartz Marius & Vincent Daniel R., 2006. "The No Surcharge Rule and Card User Rebates: Vertical Control by a Payment Network," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
  2. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  3. Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
  4. James McAndrews & Zhu Wang, 2012. "The economics of two-sided payment card markets: pricing, adoption and usage," Working Paper 12-06, Federal Reserve Bank of Richmond.
  5. Terri Bradford, 2008. "Developments in interchange fees in the United States and abroad," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Apr.
  6. Baxter, William F, 1983. "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, University of Chicago Press, vol. 26(3), pages 541-88, October.
  7. repec:fip:fedgws:y:2008:i:oct:p:a75-a106:n:v.94 is not listed on IDEAS
  8. Wang, Zhu, 2010. "Market structure and payment card pricing: What drives the interchange?," International Journal of Industrial Organization, Elsevier, vol. 28(1), pages 86-98, January.
  9. Zhu Wang, 2010. "Regulating debit cards: the case of ad valorem fees," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 71-93.
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Citations

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Cited by:
  1. Arango, Carlos & Huynh, Kim P. & Sabetti, Leonard, 2011. "How do you pay? The role of incentives at the point-of-sale," Working Paper Series 1386, European Central Bank.
  2. Wismer, Sebastian, 2013. "Intermediated vs. Direct Sales and a No-Discrimination Rule," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79999, Verein für Socialpolitik / German Economic Association.
  3. Wilko Bolt & Sujit Chakravorti, 2011. "Pricing in Retail Payment Systems: A Public Policy Perspective on Pricing of Payment Cards," DNB Working Papers 331, Netherlands Central Bank, Research Department.
  4. Jonathan Chiu & Tsz-Nga Wong, 2014. "E-Money: Efficiency, Stability and Optimal Policy," Working Papers 14-16, Bank of Canada.
  5. Adachi, Takanori & Ebina, Takeshi, 2014. "Double marginalization and cost pass-through: Weyl–Fabinger and Cowan meet Spengler and Bresnahan–Reiss," Economics Letters, Elsevier, vol. 122(2), pages 170-175.
  6. Artyom Shneyerov & Andras Niedermayer, 2011. "Search Brokers," 2011 Meeting Papers 89, Society for Economic Dynamics.
  7. Naoki Wakamori & Angelika Welte, 2012. "Why Do Shoppers Use Cash? Evidence from Shopping Diary Data," Working Papers 12-24, Bank of Canada.
  8. Zenger, Hans, 2012. "Differentiated interchange fees," Economics Letters, Elsevier, vol. 115(2), pages 276-278.
  9. Wilko Bolt, 2012. "Retail Payment Systems: Competition, Innovation, and Implications," DNB Working Papers 362, Netherlands Central Bank, Research Department.

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