The economics of two-sided payment card markets: pricing, adoption and usage

James Joseph McAndrews () and Zhu Wang ()

No RWP 08-12, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: This paper provides a new theory for two-sided payment card markets by positing better microfoundations. Adopting payment cards by consumers and merchants requires a fixed cost, but yields lower marginal costs of making payments. Considering this together with the heterogeneity of consumer income and merchant size, our theory derives card adoption and usage pattern consistent with cross-section and time-series evidence. Our analyses also help explain the observed card pricing pattern, particularly the rising merchant (interchange) fees over time. This is because a private card network, besides internalizing the two-sided market externality, has the incentive to inflate the card transaction value. We show that privately determined card pricing, adoption and usage tend to deviate from the social optimum, and imposing a ceiling on interchange fees may improve consumer welfare.

New Economics Papers: this item is included in nep-mic, nep-mkt and nep-net
Date: 2008
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