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

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  • Zhu Wang

Abstract

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.

Suggested Citation

  • Zhu Wang, 2013. "Demand externalitites and price cap regulation: Learning from a two-sided market," Working Paper 13-06, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:13-06
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    File URL: http://www.richmondfed.org/publications/research/working_papers/2013/pdf/wp13-06.pdf
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    References listed on IDEAS

    as
    1. Julian Wright, 2012. "Why payment card fees are biased against retailers," RAND Journal of Economics, RAND Corporation, vol. 43(4), pages 761-780, December.
    2. Marc Rysman, 2007. "An Empirical Analysis Of Payment Card Usage," Journal of Industrial Economics, Wiley Blackwell, vol. 55(1), pages 1-36, March.
    3. 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.
    4. 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.
    5. Ron Borzekowski & Elizabeth K. Kiser & Mark D. Manuszak & Robin A. Prager, 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. Julian Wright, 2004. "The Determinants of Optimal Interchange Fees in Payment Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 52(1), pages 1-26, March.
    7. Fumiko Hayashi, 2012. "Discounts and surcharges: implications for consumer payment choice," Payments System Research Briefing, Federal Reserve Bank of Kansas City, issue Jun.
    8. 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.
    9. Richard Schmalensee, 2002. "Payment Systems and Interchange Fees," Journal of Industrial Economics, Wiley Blackwell, vol. 50(2), pages 103-122, June.
    10. Fumiko Hayashi, 2013. "The new debit card regulations: effects on merchants, consumers, and payments system efficiency," Economic Review, Federal Reserve Bank of Kansas City, vol. 98(Q I), pages 89-118.
    11. repec:bla:jindec:v:50:y:2002:i:2:p:103-22 is not listed on IDEAS
    12. 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.
    13. 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.
    14. Zhu Wang, 2012. "Debit card interchange fee regulation: some assessments and considerations," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 98(3Q), pages 159-182.
    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 541-588, October.
    16. Wright Julian, 2010. "Why Do Merchants Accept Payment Cards?," Review of Network Economics, De Gruyter, vol. 9(3), pages 1-8, August.
    17. Wilko Bolt & Sujit Chakravorti, 2008. "Consumer choice and merchant acceptance of payment media," Working Paper Series WP-08-11, Federal Reserve Bank of Chicago.
    18. Jean-Charles Rochet Author-Email:rochet@cict.fr Author-Workplace-Name: IDEI, University of Toulouse & Jean Tirole Author-Email: tirole@cict.fr Author-Workplace-Name: IDEI, University of Toulouse, 2006. "Two-Sided Markets: A Progress Report," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 645-667, Autumn.
    19. Wilko Bolt & Sujit Chakravorti, 2008. "Consumer choice and merchant acceptance of payment media," Working Paper Series WP-08-11, Federal Reserve Bank of Chicago.
    20. Mark Armstrong Author-Email: mark.armstrong@ucl.ac.uk Author-Workplace-Name: University College of London, 2006. "Competition in Two-Sided Markets," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 668-691, Autumn.
    21. 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.
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    Cited by:

    1. Kevin Foster & Scott Schuh & Hanbing Zhang, 2013. "The 2010 Survey of Consumer Payment Choice," Research Data Report 13-2, Federal Reserve Bank of Boston.
    2. Oz Shy, 2014. "Measuring Some Effects Of The 2011 Debit Card Interchange Fee Reform," Contemporary Economic Policy, Western Economic Association International, vol. 32(4), pages 769-783, October.
    3. Neil Mitchell & Scarlett Schwartz & Zhu Wang, 2014. "The Impact of the Durbin Amendment on Merchants: A Survey Study," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 183-208.

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    Keywords

    Financial markets; Payment systems; Law and legislation;
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