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Demand externalitites and price cap regulation: Learning from a two-sided market

  • Zhu Wang
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This paper studies unintended consequences of price cap regulation in the presence of demand externalities in the context of payment cards. The recent U.S. debit card regulation was intended to lower merchant card acceptance costs by capping the maximum interchange fee. However, small-ticket merchants found their fees instead higher after the regulation. To address this puzzle, I construct a two-sided market model and show that card demand externalities across merchant sectors rationalize card networks’ pricing response. Based on the model, I study socially optimal card fees and an alternative cap regulation that may avoid the unintended consequence on small-ticket merchants.

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File URL: http://www.richmondfed.org/publications/research/working_papers/2013/pdf/wp13-06.pdf
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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 13-06.

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Date of creation: 2013
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Handle: RePEc:fip:fedrwp:13-06
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  1. 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.
  2. Schmalensee, Richard, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-22, June.
  3. 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.).
  4. Zhu Wang, 2012. "Debit card interchange fee regulation: some assessments and considerations," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 159-182.
  5. Julian Wright, 2012. "Why payment card fees are biased against retailers," RAND Journal of Economics, RAND Corporation, vol. 43(4), pages 761-780, December.
  6. repec:rje:randje:v:37:y:2006:3:p:645-667 is not listed on IDEAS
  7. Fumiko Hayashi, 2013. "The new debit card regulations: effects on merchants, consumers, and payments system efficiency," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 89-118.
  8. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, 03.
  9. 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.
  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. Gans Joshua S & King Stephen P, 2003. "The Neutrality of Interchange Fees in Payment Systems," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-18, January.
  12. James McAndrews & Zhu Wang, 2012. "The economics of two-sided payment card markets: pricing, adoption and usage," Working Paper 12-06, Federal Reserve Bank of Richmond.
  13. Wright Julian, 2010. "Why Do Merchants Accept Payment Cards?," Review of Network Economics, De Gruyter, vol. 9(3), pages 1-8, August.
  14. repec:rje:randje:v:37:y:2006:3:p:668-691 is not listed on IDEAS
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