Efficiency and Competition between Payment Instruments

Joseph Farrell ()

Review of Network Economics, 2006, vol. 5, issue 1, 19

Abstract: A payment instrument that disproportionately charges merchants (as with high interchange) can take business from others that offer the two-sided customer better deals. This competitive bias arises because merchants internalize cardholders' benefits (even without merchant competition). Use of an instrument with high merchant fees also raises prices paid by other consumers, a non-pecuniary externality. While it can be allocatively efficient to tax rivals of a firm (or cooperative) with market power, competition policy urges otherwise. The competitive bias and the externality on other consumers vanish when competing payment instruments are equally costly to merchants, suggesting a simple policy benchmark.

Date: 2006
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DOI: 10.2202/1446-9022.1087

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