Who Pays for Credit Cards?

Abstract

The authors model side payments in a competitive credit‐card market. If competitive retailers absorb the cost of accepting credit cards by charging a higher goods price to everyone, then someone must subsidize convenience users of credit cards to prevent them from defecting to merchants who do not accept cards. The side payment could be financed by card users who roll over balances and pay interest. It is rational for them to do so if their subjective discount rates are high enough. Charging different prices to different customers based on the underlying cost of the payment instrument would be more efficient for retailers. However, banks may offer incentives to attract convenience users because some of them may become interest‐paying users (“revolvers”) in the future.

Technological platforms

“…As an example, Microsoft attracted Electronic Arts to produce games for the Xbox platform by offering them reduced fees (Eisenmann et al 2006). Despite the benefits of price discrimination and its observed existence, however, the literature often assumes the absence of such discrimination (Chakravorti and Emmons 2003;Rochet and Tirole 2006). This assumption is due to both the literature's methodological limits and its frequent examination of non-technological platforms, where price discrimination is harder to realize.…”

A theory of credit cards

“…6 4 Rochet and Tirole (2002), Schwartz and Vincent (2006), and Wright (2000) also assume noncompetitive goods markets in their credit card models. Chakravorti and Emmons (2003), Gans and King (2003b), and Wright (2000) consider competitive goods markets. 5 We do not allow merchants to issue their own credit cards.…”

“…However, there are different views in the academic literature about the welfare effects of setting different prices based on the payment instrument used (see Chakravorti, 2003). Chakravorti and Emmons (2003) suggest such a pricing strategy improves welfare given competitive markets when issuers offer incentives to convenience users who do not share in the cost of providing payment services. Schwartz and Vincent (2006) suggest that consumer surplus may be lower if merchants charge the same price for credit card and cash purchases.…”

“…Much of the literature to date focuses on the determination of the interchange fee, the fee that the merchant's financial institution pays the consumer's financial institution, in a one-period model and ignores the intertemporal aspects of credit cards. 3 With the exception of Chakravorti and Emmons (2003), we present the only model that studies the costs and benefits of extending credit to consumers. First, rather than taking a reduced form approach where the costs and benefits of credit cards are exogenously assigned functional forms, we specify a model which endogenously yields costs and benefits to the involved parties.…”

Market structure and information in payment card markets

“…The interchange fee is the amount the bank of the merchant pays the bank of the consumer for each transaction with a card. The literature in this field can generally be divided into models with a single payment card, e.g., [12][13][14][15], and those contributions that address the competition between payment cards, see, e.g., [16][17][18][19]. A multi-agent-based four-party scheme model, which studies the effect of interchange fees on the payment card adoption rate, is presented in [20].…”