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Market structure and payment card pricing: What drives the interchange?

  • Wang, Zhu
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This paper provides a new theory to explain empirical puzzles regarding payment card interchange fees. Our model departs from the existing two-sided market theories by arguing that the extensive margin of card usage is less important in a mature card market. Instead, we focus on card issuer entry, elastic consumer demand and the role of card transaction value. Our analysis suggests that card networks demand higher interchange fees to maximize member issuers' profits as card payments become more efficient and convenient. At equilibrium, consumer rewards and card transaction values increase with interchange fees, while consumer surplus and merchant profits may not. Based on the theoretical framework, we discuss pros and cons of policy interventions.

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Article provided by Elsevier in its journal International Journal of Industrial Organization.

Volume (Year): 28 (2010)
Issue (Month): 1 (January)
Pages: 86-98

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Handle: RePEc:eee:indorg:v:28:y:2010:i:1:p:86-98
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505551

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  1. 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.
  2. 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.
  3. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  4. Robert M. Hunt, 2003. "An introduction to the economics of payment card networks," Working Papers 03-10, Federal Reserve Bank of Philadelphia.
  5. 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.
  6. 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.
  7. Victor Stango, 2002. "Strategic responses to regulatory threat in the credit card market," Working Paper Series WP-02-02, Federal Reserve Bank of Chicago.
  8. Rochet Jean-Charles & Tirole Jean, 2003. "An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-11, June.
  9. 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.
  10. James McAndrews & Zhu Wang, 2012. "The economics of two-sided payment card markets: pricing, adoption and usage," Working Paper 12-06, Federal Reserve Bank of Richmond.
  11. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  12. Oz Shy & Zhu Wang, 2008. "Why do card issuers charge proportional fees?," Research Working Paper RWP 08-13, Federal Reserve Bank of Kansas City.
  13. 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.
  14. 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.
  15. Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
  16. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  17. Marc Rysman, 2006. "An Empirical Analysis of Payment Card Usage," Boston University - Department of Economics - Working Papers Series WP2006-002, Boston University - Department of Economics.
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