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Price Differentiation and Menu Costs in Credit Card Payments

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  • Marcos Valli Jorge

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  • Wilfredo Leiva Maldonado

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Abstract

We 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 Info

Paper 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.

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Length: 38 Pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:acb:cbeeco:2012-592

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  1. Weiner Stuart E. & Wright Julian, 2005. "Interchange Fees in Various Countries: Developments and Determinants," Review of Network Economics, De Gruyter, De Gruyter, vol. 4(4), pages 1-34, December.
  2. Rochet Jean-Charles & Tirole Jean, 2006. "Externalities and Regulation in Card Payment Systems," Review of Network Economics, De Gruyter, De Gruyter, vol. 5(1), pages 1-14, March.
  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. Rochet Jean-Charles, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, De Gruyter, vol. 2(2), pages 1-28, June.
  5. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, Elsevier, vol. 47(4), pages 587-612, August.
  6. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 25(3), pages 583-595, June.
  7. Rochet, Jean-Charles & Wright, Julian, 2010. "Credit card interchange fees," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(8), pages 1788-1797, August.
  8. Wang, Zhu, 2010. "Market structure and payment card pricing: What drives the interchange?," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 28(1), pages 86-98, January.
  9. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  10. Terri Bradford, 2008. "Developments in interchange fees in the United States and abroad," Payments System Research Briefing, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, issue Apr.
  11. Schuh, Scott & Stavins, Joanna, 2010. "Why are (some) consumers (finally) writing fewer checks? The role of payment characteristics," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(8), pages 1745-1758, August.
  12. Sujit Chakravorti & William R. Emmons, 2001. "Who pays for credit cards?," Occasional Paper; Emerging Payments, Federal Reserve Bank of Chicago EPS-2001-1, Federal Reserve Bank of Chicago.
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Cited by:
  1. Vicente da Gama Machado & Marcelo Savino Portugal, 2013. "Measuring Inflation Persistence in Brazil Using a Multivariate Model," Working Papers Series, Central Bank of Brazil, Research Department 331, Central Bank of Brazil, Research Department.

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