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Interchange Fees in Payment Networks: Implications for Prices, Profits, and Welfare

Author

Listed:
  • Robert M. Hunt
  • Konstantinos Serfes
  • Yin Zhang

Abstract

In a two-sided model of the payment card market, we introduce a specific form of elastic demand (constant elasticity), merchant market power, ad valorem fees, and cash as an alternative. We derive the “credit card tax,” consisting of an endogenously determined interchange fee and any rewards paid. We characterize how this tax influences prices, profits, and welfare. We also examine how these relationships vary under different assumptions about the elasticity of demand, merchant market power, and differentiation between cash and credit. Under the assumptions of our model, by endogenizing the credit card tax, we show that capping interchange fees benefits all consumers by lowering these taxes, even if rewards decrease.

Suggested Citation

  • Robert M. Hunt & Konstantinos Serfes & Yin Zhang, 2025. "Interchange Fees in Payment Networks: Implications for Prices, Profits, and Welfare," Working Papers 25-18, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:100061
    DOI: 10.21799/frbp.wp.2025.18
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    More about this item

    Keywords

    credit cards; two sided networks; merchant competition; interchange fees; regulation;
    All these keywords.

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L40 - Industrial Organization - - Antitrust Issues and Policies - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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