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Consumer choice and merchant acceptance of payment media

  • Wilko Bolt
  • Sujit Chakravorti

We study the ability of banks and merchants to influence the consumer's payment instrument choice. Consumers participate in payment card networks to insure themselves against three types of shocks -- income, theft, and their merchant match. Merchants choose which payment instruments to accept based on their production costs and increased profit opportunities. Our key results can be summarized as follows. The structure of prices is determined by the level of the bank's cost to provide payment services including the level of aggregate credit loss, the probability of theft, and the timing of income inflows. We also identify equilibria where the bank finds it profitable to offer one or both payment cards. Our model predicts that when merchants are restricted to charging a uniform price for goods that they sell, the bank benefits while consumers and merchants are worse off. Finally, we compare welfare-maximizing price structures to those that result from the bank's profit-maximizing price structure.

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Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-08-11.

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Date of creation: 2008
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Handle: RePEc:fip:fedhwp:wp-08-11
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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. James McAndrews & Zhu Wang, 2006. "Microfoundations of two-sided markets: the payment card example," Payments System Research Working Paper PSR WP 06-01, Federal Reserve Bank of Kansas City.
  3. Ping He & Lixin Huang & Randall Wright, 2005. "Money And Banking In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 637-670, 05.
  4. Benjamin E. Hermalin & Michael L. Katz, 2004. "Sender or Receiver: Who Should Pay to Exchange an Electronic Message?," RAND Journal of Economics, The RAND Corporation, vol. 35(3), pages 423-447, Autumn.
  5. 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.
  6. W. Bolt, 2003. "Retail Payments in the Netherlands: some Facts and Some Theory," WO Research Memoranda (discontinued) 722, Netherlands Central Bank, Research Department.
  7. Terri Bradford, 2008. "Developments in interchange fees in the United States and abroad," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Apr.
  8. Jean-Charles Rochet & Jean Tirole, 2003. "Platform Competition in Two-Sided Markets," Journal of the European Economic Association, MIT Press, vol. 1(4), pages 990-1029, 06.
  9. Jean Tirole & Jean-Charles Rochet, 2006. "Two-Sided Markets : A Progress Report," Post-Print hal-00173715, HAL.
  10. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  11. JOHN M. Barron & MICHAEL E. Staten & JOHN Umbeck, 1992. "Discounts For Cash In Retail Gasoline Marketing," Contemporary Economic Policy, Western Economic Association International, vol. 10(4), pages 89-102, October.
  12. Humphrey, David B., 2004. "Replacement of cash by cards in US consumer payments," Journal of Economics and Business, Elsevier, vol. 56(3), pages 211-225.
  13. Chakravorti, Sujit & To, Ted, 2007. "A theory of credit cards," International Journal of Industrial Organization, Elsevier, vol. 25(3), pages 583-595, June.
  14. repec:rje:randje:v:37:y:2006:3:p:645-667 is not listed on IDEAS
  15. Sujit Chakravorti & William R. Emmons, 2001. "Who pays for credit cards?," Occasional Paper; Emerging Payments EPS-2001-1, Federal Reserve Bank of Chicago.
  16. Sujit Chakravorti & Roberto Roson, 2004. "Platform competition in two-sided markets: the case of payment networks," Working Paper Series WP-04-09, Federal Reserve Bank of Chicago.
  17. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  18. Bolt, Wilko & Tieman, Alexander F., 2008. "Heavily skewed pricing in two-sided markets," International Journal of Industrial Organization, Elsevier, vol. 26(5), pages 1250-1255, September.
  19. 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.
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