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

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Listed:
  • James J. McAndrews
  • Zhu Wang

Abstract

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.

Suggested Citation

  • James J. McAndrews & Zhu Wang, 2008. "The economics of two-sided payment card markets: pricing, adoption and usage," Research Working Paper RWP 08-12, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:rwp08-12
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    References listed on IDEAS

    as
    1. Jean‐Charles Rochet & Jean Tirole, 2006. "Two‐sided markets: a progress report," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 645-667, September.
    2. 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.
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    4. 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.).
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    6. Richard J. Sullivan & Zhu Wang, 2005. "Internet banking: an exploration in technology diffusion and impact," Payments System Research Working Paper PSR WP 05-05, Federal Reserve Bank of Kansas City.
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    14. 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.
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    Cited by:

    1. Wang, Zhu, 2016. "Price cap regulation in a two-sided market: Intended and unintended consequences," International Journal of Industrial Organization, Elsevier, vol. 45(C), pages 28-37.
    2. Nicole Jonker, 2018. "What drives bitcoin adoption by retailers," DNB Working Papers 585, Netherlands Central Bank, Research Department.
    3. Wang, Zhu & Wolman, Alexander L., 2014. "Payment Choice and the Future of Currency: Insights from Two Billion Retail Transactions," Working Paper 14-9, Federal Reserve Bank of Richmond.
    4. Oz Shy & Zhu Wang, 2008. "Why do card issuers charge proportional fees?," Research Working Paper RWP 08-13, Federal Reserve Bank of Kansas City.
    5. Lotz, Sébastien & Zhang, Cathy, 2016. "Money and credit as means of payment: A new monetarist approach," Journal of Economic Theory, Elsevier, vol. 164(C), pages 68-100.
    6. 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.
    7. Jonker Nicole, 2011. "Card Acceptance and Surcharging: the Role of Costs and Competition," Review of Network Economics, De Gruyter, vol. 10(2), pages 1-35, June.
    8. Nicole Jonker & Anneke Kosse & Lola Hernández, 2012. "Cash usage in the Netherlands: How much, where, when, who and whenever one wants?," DNB Occasional Studies 1002, Netherlands Central Bank, Research Department.
    9. Zhu Wang, 2013. "Demand externalitites and price cap regulation: Learning from a two-sided market," Working Paper 13-06, Federal Reserve Bank of Richmond.
    10. Zhu Wang, 2012. "Debit card interchange fee regulation: some assessments and considerations," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 159-182.
    11. Korsgaard, Søren, 2014. "Paying for payments: free payments and optimal interchange fees," Working Paper Series 1682, European Central Bank.
    12. 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.).
    13. Wilko Bolt & Sujit Chakravorti, 2010. "Digitization of Retail Payment," DNB Working Papers 270, Netherlands Central Bank, Research Department.
    14. Wang, Zhu & Wolman, Alexander L., 2016. "Payment choice and currency use: Insights from two billion retail transactions," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 94-115.
    15. Oz Shy & Zhu Wang, 2011. "Why Do Payment Card Networks Charge Proportional Fees?," American Economic Review, American Economic Association, vol. 101(4), pages 1575-1590, June.

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