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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
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Handle: RePEc:fip:fedkrw:rwp08-12
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  1. Richard Sullivan & Zhu Wang, 2013. "Internet banking: an exploration in technology diffusion and impact," Working Paper 13-10, Federal Reserve Bank of Richmond.
  2. 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.
  3. 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.
  4. Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
  5. 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.).
  6. Stuart E. Weiner & Julian Wright, 2005. "Interchange fees in various countries : developments and determinants," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City, issue May, pages 5-49.
  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. repec:rje:randje:v:37:y:2006:3:p:668-691 is not listed on IDEAS
  9. repec:rje:randje:v:37:y:2006:3:p:645-667 is not listed on IDEAS
  10. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  11. 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.
  12. 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.
  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. 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.
  15. Bedre-Defolie, Özlem & Calvano, Emilio, 2009. "Pricing payment cards," Working Paper Series 1139, European Central Bank.
  16. 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.
  17. Sujit Chakravorti, 2003. "Theory of credit card networks: a survey of the literature," Payment Cards Center Discussion Paper 03-09, Federal Reserve Bank of Philadelphia.
  18. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  19. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  20. 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.
  21. 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.
  22. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
  23. 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.
  24. Robert M. Hunt, 2003. "An introduction to the economics of payment card networks," Working Papers 03-10, Federal Reserve Bank of Philadelphia.
  25. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
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