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Payment Systems and Interchange Fees

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  • Richard Schmalensee

Abstract

In a typical bank credit card transaction, the merchant's bank pays an interchange fee, collectively determined by all participating banks, to the cardholder's bank. This paper shows how the interchange fee balances charges between cardholders and merchants under imperfect competition. The privately optimal fee depends mainly on differences between cardholders' and merchants' banks, not their collective market power. In a non-extreme case, the profit-maximizing interchange fee also maximizes total output and producers' plus consumers' surplus. There is no economic basis for favoring proprietary payment systems, which do not need interchange fees to balance charges, over the cooperative bank card systems.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8256.

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Date of creation: Apr 2001
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Publication status: published as Schmalensee, Richard. "Payment Systems And Interchange Fees," Journal of Industrial Economics, 2002, v50(2,Jun), 103-122.
Handle: RePEc:nbr:nberwo:8256

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  1. Schmalensee, Richard, 1976. "A Model of Promotional Competition in Oligopoly," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 43(3), pages 493-507, October.
  2. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Baxter, William F, 1983. "Bank Interchange of Transactional Paper: Legal and Economic Perspectives," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 26(3), pages 541-88, October.
  4. Dixit, Avinash K, 1986. "Comparative Statics for Oligopoly," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(1), pages 107-22, February.
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