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

  • James McAndrews
  • Zhu Wang

This paper provides a new theory for two-sided payment card markets by positing better microfoundations. Adopting payment cards by consumers and merchants requires a fixed cost, but yields lower marginal costs of making payments. Considering this together with the heterogeneity of consumer income and merchant size, our theory derives card adoption and usage pattern consistent with cross-section and time-series evidence. Our analyses also help explain the observed card pricing pattern, particularly the rising merchant (interchange) fees over time. This is because a private card network, besides internalizing the two-sided market externality, has the incentive to inflate the card transaction value. We show that privately determined card pricing, adoption and usage tend to deviate from the social optimum, and imposing a ceiling on interchange fees may improve consumer welfare. ; Also issued as a Payments System Research Working Paper.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 08-12.

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Date of creation: 2008
Date of revision:
Handle: RePEc:fip:fedkrw:rwp08-12
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  1. ?zlem Bedre-Defolie & Emilio Calvano, 2013. "Pricing Payment Cards," American Economic Journal: Microeconomics, American Economic Association, vol. 5(3), pages 206-31, August.
  2. Hunt Robert M., 2003. "An Introduction to the Economics of Payment Card Networks," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-17, June.
  3. Richard Sullivan & Zhu Wang, 2013. "Internet banking: an exploration in technology diffusion and impact," Working Paper 13-10, Federal Reserve Bank of Richmond.
  4. Weiner Stuart E. & Wright Julian, 2005. "Interchange Fees in Various Countries: Developments and Determinants," Review of Network Economics, De Gruyter, vol. 4(4), pages 1-34, December.
  5. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  6. Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
  7. 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.
  8. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
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  12. 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.
  13. 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.
  14. Fumiko Hayashi, 2004. "A puzzle of card payment pricing : why are merchants still accepting card payments?," Payments System Research Working Paper PSR WP 04-02, Federal Reserve Bank of Kansas City.
  15. Jean Tirole & Jean-Charles Rochet, 2006. "Two-Sided Markets : A Progress Report," Post-Print hal-00173715, HAL.
  16. 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.
  17. 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.
  18. Jean-Charles Rochet & Jean Tirole, 2006. "Externalities and Regulations in Card Payment Systems," Post-Print hal-00173720, HAL.
  19. 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.).
  20. Chakravorti Sujit, 2003. "Theory of Credit Card Networks: A Survey of the Literature," Review of Network Economics, De Gruyter, vol. 2(2), pages 1-19, June.
  21. repec:rje:randje:v:37:y:2006:3:p:645-667 is not listed on IDEAS
  22. repec:rje:randje:v:37:y:2006:3:p:668-691 is not listed on IDEAS
  23. 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.
  24. 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.
  25. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  26. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  27. 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.
  28. 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.
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