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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. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  2. Weiner Stuart E. & Wright Julian, 2005. "Interchange Fees in Various Countries: Developments and Determinants," Review of Network Economics, De Gruyter, vol. 4(4), pages 1-34, December.
  3. Zhu Wang, 2006. "Technology Innovation and Market Turbulence: A Dotcom Example," 2006 Meeting Papers 508, Society for Economic Dynamics.
  4. Richard Sullivan, 2004. "Payment services and the evolution of Internet banking," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Aug.
  5. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  6. 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.
  7. Evans, David & Schmalensee, Richard, 2005. "The Economics of Interchange Fees and Their Regulation: An Overview," Working papers 18181, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  8. 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.
  9. Rodolfo Manuelli & Ananth Seshadri, 2003. "Frictionless technology diffusion: the case of tractors," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  10. 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.
  11. 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.
  12. Jean-Charles Rochet & Jean Tirole, 2007. "Must-Take Cards and the Tourist Test," DNB Working Papers 127, Netherlands Central Bank, Research Department.
  13. Mark Armstrong, 2005. "Competition in Two-Sided Markets," Industrial Organization 0505009, EconWPA.
  14. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  15. Kevin J. Stiroh, 2002. "Information Technology and the U.S. Productivity Revival: What Do the Industry Data Say?," American Economic Review, American Economic Association, vol. 92(5), pages 1559-1576, December.
  16. 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.
  17. repec:reg:rpubli:105 is not listed on IDEAS
  18. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
  19. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
  20. 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.
  21. 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.
  22. 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.
  23. 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.
  24. 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.
  25. Jovanovic, Boyan & MacDonald, Glenn M, 1994. "The Life Cycle of a Competitive Industry," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 322-47, April.
  26. 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.
  27. 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.
  28. 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.
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Cited by:
  1. Wilko Bolt & Sujit Chakravorti, 2008. "Economics of Payment Cards: A Status Report," DNB Working Papers 193, Netherlands Central Bank, Research Department.
  2. Wilko Bolt & Sujit Chakravorti, 2008. "Consumer choice and merchant acceptance of payment media," Working Paper Series WP-08-11, Federal Reserve Bank of Chicago.
  3. Krueger, Malte, 2009. "The Pricing of Payments," MPRA Paper 24759, University Library of Munich, Germany.
  4. 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.
  5. 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.
  6. 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.
  7. Bolt, Wilko & Schmiedel, Heiko, 2009. "SEPA, efficiency, and payment card competition," Working Paper Series 1140, European Central Bank.
  8. 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.
  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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