Working Paper

Demand externalitites and price cap regulation: Learning from a two-sided market

Abstract: This paper studies unintended consequences of price cap regulation in the presence of demand externalities in the context of payment cards. The recent U.S. debit card regulation was intended to lower merchant card acceptance costs by capping the maximum interchange fee. However, small-ticket merchants found their fees instead higher after the regulation. To address this puzzle, I construct a two-sided market model and show that card demand externalities across merchant sectors rationalize card networks? pricing response. Based on the model, I study socially optimal card fees and an alternative cap regulation that may avoid the unintended consequence on small-ticket merchants.

Keywords: Financial markets; Payment systems; Law and legislation;

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2013

Number: 13-06