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The Determinants of Optimal Interchange Fees in Payment Systems

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  • Wright, Julian

Abstract

A fundamental aspect of any open payment system is the interchange fee that is paid from the merchant's bank to the cardholder's bank. Using a model in which there is partial participation by heterogeneous consumers and merchants, this paper characterizes the output maximizing, profit maximizing and welfare maximizing level of such an interchange fee. It examines how the optimal level of the fee depends on costs, profits margins, pass-through coefficients, participation rates, and membership fees, as well as two different strategic effects arising from competition between merchants. It also determines the factors which drive deviations between the output maximizing, profit maximizing, and welfare maximizing interchange fees.

Suggested Citation

  • Wright, Julian, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Working Papers 176, Department of Economics, The University of Auckland.
  • Handle: RePEc:auc:wpaper:176
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    File URL: http://hdl.handle.net/2292/176
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    References listed on IDEAS

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    1. Jean-Jacques Laffont & Jean Tirole, 2001. "Competition in Telecommunications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262621509, September.
    2. Marius Schwartz & Daniel Vincent, 2002. "Same Price, Cash, or Card: Vertical Control by Payment Networks," Working Papers gueconwpa~02-02-01, Georgetown University, Department of Economics.
    3. 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 541-588, October.
    4. Rochet, Jean-Charles & Tirole, Jean, 1999. "Cooperation Among Competitors: The Economics of Credit Card Associations," CEPR Discussion Papers 2101, C.E.P.R. Discussion Papers.
    5. Sujit Chakravorti & William R. Emmons, 2001. "Who pays for credit cards?," Occasional Paper; Emerging Payments EPS-2001-1, Federal Reserve Bank of Chicago.
    6. Julian Wright, 2002. "Access Pricing under Competition: An Application to Cellular Networks," Journal of Industrial Economics, Wiley Blackwell, vol. 50(3), pages 289-315, September.
    7. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, March.
    8. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
    9. Armstrong, Mark, 2001. "The theory of access pricing and interconnection," MPRA Paper 15608, University Library of Munich, Germany.
    10. Richard Schmalensee, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-122, June.
    11. 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.
    12. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
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    More about this item

    Keywords

    Economics;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L31 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Nonprofit Institutions; NGOs; Social Entrepreneurship
    • L42 - Industrial Organization - - Antitrust Issues and Policies - - - Vertical Restraints; Resale Price Maintenance; Quantity Discounts

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