Working Paper

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

Abstract: This paper provides a new theory for two-sided payment card markets. Adopting payment cards requires consumers and merchants to pay a fixed cost, but yields a lower marginal cost of making payments. Analyzing adoption and usage externalities among heterogeneous consumers and merchants, our theory derives the equilibrium card adoption and usage pattern consistent with empirical evidence. Our analysis also helps explain the card pricing puzzles, particularly the high and rising merchant (interchange) fees. Based on the theoretical framework, we discuss socially desirable payment card fees as well as the interchange fee cap regulation.

Keywords: Financial markets; Payment systems;

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2012

Number: 12-06