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 Rochet and Wright (2010) approach, but assuming a credit card system without a no-surcharge rule or any type of price differentiation disincentive. 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 displacing the aggregated consumers’ welfare from its maximum. We prove that the average price obtained under price differentiation is smaller than the single retail price under the no-surcharge rule, despite the retailer’s margins being the same in both scenarios. Furthermore, we show how some cross subsidies are eliminated when price differentiation is allowed. In addition, we introduce menu costs to prove that there is a threshold value for the interchange fee such that price differentiation is equilibrium if that fee is above this value. The threshold may be interpreted as an endogenous cap for the interchange fee fixed by the credit card industry. Finally we conclude that, even with menu costs associated to price differentiation, the consumers’ welfare can be greater in the price differentiated equilibrium than in the single price equilibrium under the non-surcharge rule.
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Bibliographic InfoPaper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 315.
Date of creation: Jul 2013
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Other versions of this item:
- 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.
- 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-2013-08-05 (All new papers)
- NEP-BAN-2013-08-05 (Banking)
- NEP-COM-2013-08-05 (Industrial Competition)
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