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The economics of two-sided payment card markets: pricing, adoption and usage

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  • James McAndrews
  • Zhu Wang

Abstract

This paper provides a new theory for two-sided payment card markets. Adopting payment cards requires consumers and merchants to pay a fixed cost, but yields a lower marginal cost of making payments. Analyzing adoption and usage externalities among heterogeneous consumers and merchants, our theory derives the equilibrium card adoption and usage pattern consistent with empirical evidence. Our analysis also helps explain the card pricing puzzles, particularly the high and rising merchant (interchange) fees. Based on the theoretical framework, we discuss socially desirable payment card fees as well as the interchange fee cap regulation.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 12-06.

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Date of creation: 2012
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Handle: RePEc:fip:fedrwp:12-06

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Keywords: Financial markets ; Payment systems;

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References

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  1. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  2. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414.
  3. Mark Armstrong, 2006. "Competition in two‐sided markets," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 668-691, 09.
  4. 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.
  5. Sujit Chakravorti, 2003. "Theory of Credit Card Networks: A Survey of the Literature," Review of Network Economics, De Gruyter, vol. 2(2), pages 1.
  6. Robert M. Hunt, 2003. "An introduction to the economics of payment card networks," Working Papers 03-10, Federal Reserve Bank of Philadelphia.
  7. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  8. Özlem Bedre-Defolie & Emilio Calvano, 2009. "Pricing payment cards," Working Paper Series 1139, European Central Bank.
  9. Baxter, William F, 1983. "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, University of Chicago Press, vol. 26(3), pages 541-88, October.
  10. Marius Schwartz & Daniel R. Vincent, 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 6.
  11. Robin A. Prager & Mark D. Manuszak & Elizabeth K. Kiser & Ron Borzekowski, 2009. "Interchange fees and payment card networks: economics, industry developments, and policy issues," Finance and Economics Discussion Series 2009-23, Board of Governors of the Federal Reserve System (U.S.).
  12. Jean-Charles Rochet & Jean Tirole, 2006. "Externalities and Regulation in Card Payment Systems," Review of Network Economics, De Gruyter, vol. 5(1), pages 1.
  13. Jean-Charles Rochet & Jean Tirole, 2003. "An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 2.
  14. Joseph Farrell, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 3.
  15. 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.
  16. Zhu Wang, 2008. "Income Distribution, Market Size and the Evolution of Industry," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 542-565, July.
  17. Rochet, Jean-Charles & Tirole, Jean, 2006. "Two-Sided Markets: A Progress Report," Open Access publications from University of Toulouse 1 Capitole http://neeo.univ-tlse1.fr, University of Toulouse 1 Capitole.
  18. 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.
  19. Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
  20. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
  21. 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.
  22. Wang, Zhu, 2010. "Market structure and payment card pricing: What drives the interchange?," International Journal of Industrial Organization, Elsevier, vol. 28(1), pages 86-98, January.
  23. Fumiko Hayashi, 2006. "A Puzzle of Card Payment Pricing: Why Are Merchants Still Accepting Card Payments?," Review of Network Economics, De Gruyter, vol. 5(1), pages 9.
  24. Jean-Charles Rochet, 2003. "The Theory of Interchange Fees: A Synthesis of Recent Contributions," Review of Network Economics, De Gruyter, vol. 2(2), pages 4.
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Citations

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Cited by:
  1. Robin A. Prager & Mark D. Manuszak & Elizabeth K. Kiser & Ron Borzekowski, 2009. "Interchange fees and payment card networks: economics, industry developments, and policy issues," Finance and Economics Discussion Series 2009-23, Board of Governors of the Federal Reserve System (U.S.).
  2. Oz Shy & Zhu Wang, 2008. "Why do card issuers charge proportional fees?," Research Working Paper RWP 08-13, Federal Reserve Bank of Kansas City.
  3. Wilko Bolt & Sujit Chakravorti, 2010. "Digitization of Retail Payment," DNB Working Papers 270, Netherlands Central Bank, Research Department.
  4. Nicole Jonker, 2011. "Card acceptance and surcharging: the role of costs and competition," DNB Working Papers 300, Netherlands Central Bank, Research Department.
  5. Wang, Zhu, 2010. "Market structure and payment card pricing: What drives the interchange?," International Journal of Industrial Organization, Elsevier, vol. 28(1), pages 86-98, January.
  6. Nicole Jonker & Anneke Kosse & Lola Hernández, 2012. "Cash usage in the Netherlands: How much, where, when, who and whenever one wants?," DNB Occasional Studies 1002, Netherlands Central Bank, Research Department.
  7. Oz Shy & Zhu Wang, 2011. "Why Do Payment Card Networks Charge Proportional Fees?," American Economic Review, American Economic Association, vol. 101(4), pages 1575-90, June.

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