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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. Adopting payment cards requires consumers and merchants to pay a fixed cost, but yields a lower marginal cost of making payments. Analyzing adoption and usage externalities among heterogeneous consumers and merchants, our theory derives the equilibrium card adoption and usage pattern consistent with empirical evidence. Our analysis also helps explain the card pricing puzzles, particularly the high and rising merchant (interchange) fees. Based on the theoretical framework, we discuss socially desirable payment card fees as well as the interchange fee cap regulation.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 12-06.

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Date of creation: 2012
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Handle: RePEc:fip:fedrwp:12-06
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  1. 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.
  2. 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.
  3. 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.
  4. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  5. repec:rje:randje:v:37:y:2006:3:p:668-691 is not listed on IDEAS
  6. 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.
  7. Wright, Julian, 2003. "Optimal card payment systems," European Economic Review, Elsevier, vol. 47(4), pages 587-612, August.
  8. 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.
  9. Farrell Joseph, 2006. "Efficiency and Competition between Payment Instruments," Review of Network Economics, De Gruyter, vol. 5(1), pages 1-19, March.
  10. 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.
  11. repec:rne:rneart:v:5:y:2006:i:1:p:71-102 is not listed on IDEAS
  12. Julian Wright, 2001. "The Determinants of Optimal Interchange Fees in Payment Systems," Industrial Organization 0108001, EconWPA.
  13. Özlem Bedre-Defolie & Emilio Calvano, 2010. "Pricing payment cards," ESMT Research Working Papers ESMT-10-005, ESMT European School of Management and Technology.
  14. repec:rje:randje:v:37:y:2006:3:p:645-667 is not listed on IDEAS
  15. 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.
  16. Robert M. Hunt, 2003. "An introduction to the economics of payment card networks," Working Papers 03-10, Federal Reserve Bank of Philadelphia.
  17. 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.
  18. 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.
  19. Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  20. 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.
  21. 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.).
  22. 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.
  23. 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.
  24. 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.
  25. 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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