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Payment Systems and Interchange Fees

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  • Richard Schmalensee

Abstract

In a typical bank credit card transaction, the merchant's bank pays an interchange fee, collectively determined by all participating banks, to the cardholder's bank. This paper shows how the interchange fee balances charges between cardholders and merchants under imperfect competition. The privately optimal fee depends mainly on differences between cardholders' and merchants' banks, not their collective market power. In a non-extreme case, the profit-maximizing interchange fee also maximizes total output and producers' plus consumers' surplus. There is no economic basis for favoring proprietary payment systems, which do not need interchange fees to balance charges, over the cooperative bank card systems.

Suggested Citation

  • Richard Schmalensee, 2001. "Payment Systems and Interchange Fees," NBER Working Papers 8256, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8256
    Note: IO
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    File URL: http://www.nber.org/papers/w8256.pdf
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    References listed on IDEAS

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    1. Richard Schmalensee, 1976. "A Model of Promotional Competition in Oligopoly," Review of Economic Studies, Oxford University Press, vol. 43(3), pages 493-507.
    2. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
    3. 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.
    4. Dixit, Avinash K, 1986. "Comparative Statics for Oligopoly," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(1), pages 107-122, February.
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    Cited by:

    1. 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.
    2. W. Bolt, 2003. "Retail Payments in the Netherlands: some Facts and Some Theory," WO Research Memoranda (discontinued) 722, Netherlands Central Bank, Research Department.
    3. Kari Kemppainen, 2004. "Competition and regulation in European retail payment systems," Microeconomics 0404008, University Library of Munich, Germany.
    4. Kemppainen, Kari, 2003. "Competition and regulation in European retail payment systems," Research Discussion Papers 16/2003, Bank of Finland.
    5. Dulleck Uwe & Friederiszick Hans W., 2004. "Die Großen Zwei – Wettbewerb im Kreditkartenmarkt? / The Big Two – How Competitive is the Market for Credit Cards," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 224(4), pages 445-470, August.
    6. W. Bolt & A.F. Tieman, 2003. "Pricing Debit Card Payments Services: An IO approach," WO Research Memoranda (discontinued) 735, Netherlands Central Bank, Research Department.
    7. Juan, Iranzo & Pascual, Fernández & Gustavo, Matías & Manuel, Delgado, 2012. "The effects of the mandatory decrease of interchange fees in Spain," MPRA Paper 43097, University Library of Munich, Germany.

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    JEL classification:

    • L - Industrial Organization

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