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Market structure and payment card pricing: What drives the interchange?

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  • Wang, Zhu
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Abstract

This paper provides a new theory to explain empirical puzzles regarding payment card interchange fees. Our model departs from the existing two-sided market theories by arguing that the extensive margin of card usage is less important in a mature card market. Instead, we focus on card issuer entry, elastic consumer demand and the role of card transaction value. Our analysis suggests that card networks demand higher interchange fees to maximize member issuers' profits as card payments become more efficient and convenient. At equilibrium, consumer rewards and card transaction values increase with interchange fees, while consumer surplus and merchant profits may not. Based on the theoretical framework, we discuss pros and cons of policy interventions.

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Bibliographic Info

Article provided by Elsevier in its journal International Journal of Industrial Organization.

Volume (Year): 28 (2010)
Issue (Month): 1 (January)
Pages: 86-98

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Handle: RePEc:eee:indorg:v:28:y:2010:i:1:p:86-98

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Web page: http://www.elsevier.com/locate/inca/505551

Related research

Keywords: Payment cards Market structure Interchange fee;

References

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  1. Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
  2. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  3. Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-28, June.
  4. James McAndrews & Zhu Wang, 2008. "The economics of two-sided payment card markets: pricing, adoption and usage," Research Working Paper RWP 08-12, Federal Reserve Bank of Kansas City.
  5. Oz Shy & Zhu Wang, 2008. "Why do card issuers charge proportional fees?," Research Working Paper RWP 08-13, Federal Reserve Bank of Kansas City.
  6. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  7. Rochet Jean-Charles & Tirole Jean, 2003. "An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-11, June.
  8. Jean-Charles Rochet & Jean Tirole, 2002. "Cooperation Among Competitors: Some Economics Of Payment Card Associations," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 549-570, Winter.
  9. Fumiko Hayashi, 2004. "A puzzle of card payment pricing : why are merchants still accepting card payments?," Payments System Research Working Paper PSR WP 04-02, Federal Reserve Bank of Kansas City.
  10. Hunt Robert M., 2003. "An Introduction to the Economics of Payment Card Networks," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-17, June.
  11. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  12. Stango, Victor, 2003. "Strategic Responses to Regulatory Threat in the Credit Card Market," Journal of Law and Economics, University of Chicago Press, vol. 46(2), pages 427-52, October.
  13. 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.
  14. 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.
  15. Rochet Jean-Charles & Tirole Jean, 2006. "Externalities and Regulation in Card Payment Systems," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-14, March.
  16. 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.
  17. Marc Rysman, 2006. "An Empirical Analysis of Payment Card Usage," Boston University - Department of Economics - Working Papers Series WP2006-002, Boston University - Department of Economics.
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Citations

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Cited by:
  1. Marcos Valli Jorge & Wilfredo Leiva Maldonado, 2012. "Price Differentiation and Menu Costs in Credit Card Payments," ANU Working Papers in Economics and Econometrics 2012-592, Australian National University, College of Business and Economics, School of Economics.
  2. James McAndrews & Zhu Wang, 2008. "The economics of two-sided payment card markets: pricing, adoption and usage," Research Working Paper RWP 08-12, Federal Reserve Bank of Kansas City.
  3. Zhu Wang, 2013. "Demand externalitites and price cap regulation: Learning from a two-sided market," Working Paper 13-06, Federal Reserve Bank of Richmond.
  4. Wilko Bolt & Sujit Chakravorti, 2010. "Digitization of Retail Payment," DNB Working Papers 270, Netherlands Central Bank, Research Department.
  5. David S. Evans & Richard Schmalensee, 2013. "The Antitrust Analysis of Multi-Sided Platform Businesses," NBER Working Papers 18783, National Bureau of Economic Research, Inc.
  6. Zhu Wang, 2012. "Debit card interchange fee regulation: some assessments and considerations," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 159-182.
  7. Oz Shy & Zhu Wang, 2011. "Why Do Payment Card Networks Charge Proportional Fees?," American Economic Review, American Economic Association, vol. 101(4), pages 1575-90, June.

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