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Microfoundations of two-sided markets: the payment card example

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  • James McAndrews
  • Zhu Wang

Abstract

This paper provides a theory of two-sided market dynamics with arguably better microfoundations. These alternative microfoundations focus on observable heterogeneities of both sides of the market in a competitive framework. The theory is rich in empirical predictions and is less dependent on a particular form of imperfect competition than other approaches. Our findings in the payment card example point to adoption costs and the distribution of consumer incomes and firm sizes as the key determinants of the shares of costs borne by each side. This result provides clear implications for industry dynamics and sheds light on the puzzle of asymmetric pricing. ; Previous title: Payment industry dynamics: a two-sided market approach

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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Payments System Research Working Paper with number PSR WP 06-01.

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Date of creation: 2006
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Handle: RePEc:fip:fedkpw:psrwp06-01

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References

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  1. Jovanovic, B. & MacDonald, G.M., 1992. "The Life-Cycle of Competitive Industry," Papers 92-09, Rochester, Business - Financial Research and Policy Studies.
  2. Mark Armstrong, 2005. "Competition in Two-Sided Markets," Industrial Organization 0505009, EconWPA.
  3. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  4. 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.
  5. Jean-Charles Rochet & Jean Tirole, 2007. "Must-Take Cards and the Tourist Test," DNB Working Papers 127, Netherlands Central Bank, Research Department.
  6. Richard J. Sullivan, 2000. "How has the adoption of Internet banking affected performance and risk in banks?," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, issue Dec, pages 1-16.
  7. Richard J. Sullivan & Zhu Wang, 2005. "Internet banking: an exploration in technology diffusion and impact," Payments System Research Working Paper PSR WP 05-05, Federal Reserve Bank of Kansas City.
  8. Kevin J. Stiroh, 2001. "Information technology and the U.S. productivity revival: what do the industry data say?," Staff Reports 115, Federal Reserve Bank of New York.
  9. Sujit Chakravorti, 2003. "Theory of credit card networks: a survey of the literature," Payment Cards Center Discussion Paper 03-09, Federal Reserve Bank of Philadelphia.
  10. Zhu Wang, 2006. "Learning, diffusion and the industry life cycle," Payments System Research Working Paper PSR WP 04-01, Federal Reserve Bank of Kansas City.
  11. Courchane, Marsha & Nickerson, David & Sullivan, Richard, 2002. "Investment in internet banking as a real option: theory and tests," Journal of Multinational Financial Management, Elsevier, vol. 12(4-5), pages 347-363.
  12. Allen N. Berger & Loretta J. Mester, 2002. "Explaining the dramatic changes in performance of U.S. banks: technological change, deregulation, and dynamic changes in competition," Working Papers 01-6, Federal Reserve Bank of Philadelphia.
  13. David S. Evans & Richard Schmalensee, 2005. "The economics of interchange fees and their regulation : an overview," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 73-120.
  14. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
  15. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, 03.
  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. Hayashi Fumiko, 2006. "A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-31, March.
  18. 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.
  19. Comin, D. & Hobijn, B., 2004. "Cross-country technology adoption: making the theories face the facts," Journal of Monetary Economics, Elsevier, vol. 51(1), pages 39-83, January.
  20. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  21. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
  22. Rodolfo Manuelli & Ananth Seshadri, 2003. "Frictionless Technology Diffusion: The Case of Tractors," NBER Working Papers 9604, National Bureau of Economic Research, Inc.
  23. Stuart E. Weiner & Julian Wright, 2005. "Interchange fees in various countries : developments and determinants," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 5-49.
  24. Richard Sullivan, 2004. "Payment services and the evolution of Internet banking," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Aug.
  25. 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.
  26. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  27. Zhu Wang, 2006. "Technology Innovation and Market Turbulence: A Dotcom Example," 2006 Meeting Papers 508, Society for Economic Dynamics.
  28. repec:reg:rpubli:105 is not listed on IDEAS
  29. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
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Citations

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Cited by:
  1. Fumiko Hayashi, 2008. "The economics of payment card fee structure: what is the optimal balance between merchant fee and payment card rewards?," Research Working Paper RWP 08-06, Federal Reserve Bank of Kansas City.
  2. Bolt, Wilko & Schmiedel, Heiko, 2009. "SEPA, efficiency, and payment card competition," Working Paper Series 1140, European Central Bank.
  3. Fumiko Hayashi, 2008. "The economics of payment card fee structure: what drives payment card rewards?," Research Working Paper RWP 08-07, Federal Reserve Bank of Kansas City.
  4. Antoine Martin & Michael Orlando, 2007. "Barriers to network-specific investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 705-728, October.
  5. Wilko Bolt & Sujit Chakravorti, 2008. "Consumer Choice and Merchant Acceptance of Payment Media," DNB Working Papers 197, Netherlands Central Bank, Research Department.
  6. Krueger, Malte, 2009. "The Pricing of Payments," MPRA Paper 24759, University Library of Munich, Germany.
  7. Zhu Wang, 2008. "Market structure and credit card pricing: what drives the interchange?," Payments System Research Working Paper PSR WP 06-04, Federal Reserve Bank of Kansas City.
  8. Wilko Bolt & Sujit Chakravorti, 2008. "Economics of Payment Cards: A Status Report," DNB Working Papers 193, Netherlands Central Bank, Research Department.
  9. Fumiko Hayashi, 2008. "The economics of payment card fee structure: policy considerations of payment card rewards," Research Working Paper RWP 08-08, Federal Reserve Bank of Kansas City.

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