Price Differentiation and Menu Costs in Credit Card Payments
AbstractWe build a model of credit card payments where the retailers are allowed to charge differential prices depending on the instrument of payment chosen by the consumer. We follow the approach in Rochet and Wright (2010) but assume a credit card system without any type of non-surcharge rule. In a Hotelling competition framework at the retailers level, the competitive equilibrium prices are computed assuming that the store credit provided by the retailer is less cost efficient than the one provided by the credit card. In accordance with the literature, we obtain that the interchange fee becomes neutral if we eliminate the no-surcharge rule, when the interchange fee loses its ability to distort the individual consumer’s decisions and displace the aggregate consumers’ welfare from its maximum level. We prove that the average price obtained under price differentiation is smaller than the single retail price under the non-surcharge rule, despite the retailer’s margins being the same in both scenarios. In addition, we introduce menu costs to prove that there is a value for the interchange fee such that there is equilibrium with price differentiation if and only if that fee is above this value. It must be interpreted as an endogenous cap for the interchange fee fixed by the credit card industry. Finally, we also obtain that under price differentiation with menu costs there is a non cooperative Nash equilibrium as in the well known “prisoner’s dilemma” game.
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Bibliographic InfoPaper provided by Australian National University, College of Business and Economics, School of Economics in its series ANU Working Papers in Economics and Econometrics with number 2012-592.
Length: 38 Pages
Date of creation: Oct 2012
Date of revision:
Other versions of this item:
- Marcos Valli Jorge & Wilfredo Leiva Maldonado, 2013. "Price Differentiation and Menu Costs in Credit Card Payments," Working Papers Series 315, Central Bank of Brazil, Research Department.
- L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
- E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-11-03 (All new papers)
- NEP-BAN-2012-11-03 (Banking)
- NEP-COM-2012-11-03 (Industrial Competition)
- NEP-IND-2012-11-03 (Industrial Organization)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Weiner Stuart E. & Wright Julian, 2005.
"Interchange Fees in Various Countries: Developments and Determinants,"
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De Gruyter, vol. 4(4), pages 1-34, December.
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- Stuart E. Weiner & Julian Wright, 2005. "Interchange fees in various countries: developments and determinants," Payments System Research Working Paper PSR WP 05-01, Federal Reserve Bank of Kansas City.
- Schmalensee, Richard, 2002.
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- 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.
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- Sujit Chakravorti & William R. Emmons, 2001. "Who pays for credit cards?," Occasional Paper; Emerging Payments EPS-2001-1, Federal Reserve Bank of Chicago.
- Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
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- 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.
- Rochet, Jean-Charles & Wright, Julian, 2009.
"Credit card interchange fees,"
Working Paper Series
1138, European Central Bank.
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