Abstract: This paper investigates the market structure of the payment card market with consumers and merchants basing their subscription decisions on various information sets. We find that the market structure depends crucially on this information set, where we observe that a market with few cards dominating only emerges when decisions are based on very limited information. For more complete information sets, more and more cards survive in the long run. The use of an agent-based model focussing on the interactions between merchants and consumers as a basis for subscription decisions allows us to investigate the dynamics of the market rather than investigating only equilibrium outcomes. Keywords: Multi-homing, two-sided markets, network externalities, agent-based modeling, competition.

In this article, we survey the recent theoretical literature on payment cards and study their implications for public policy. Payment card networks have faced regulatory scrutiny in several countries regarding the setting of various fees including interchange fees—fees paid by the merchant’s financial institution to the cardholder’s financial institution. In addition, other common payment practices such as no-surcharge rules have also been challenged in several jurisdictions. Unlike other types of markets, card payment services are network goods where two distinct end-users (i.e. consumers and merchants) must participate for the good to be consumed.

i This work is dedicated: to my husband Serafín and my children; and to my parents Svetla and Alexander. i Summary The increasing use of the credit and debit cards has converted them into important players in the world scene. In this market, the card providers deal with two different groups of users: consumers, that demand goods and merchants, that sell them. In addition, the consumers and the merchants demand electronic payment methods for their commercial transactions. The growing importance of these payment methods, explain the interest of economists and policy makers in understanding the different aspects of the market dynamics. The analytical models used for this purpose are built on representative players, whereas the large number of heterogeneous interactions among consumers, merchants and card providers is impossible to be taken into account. Nevertheless, we strongly believe that studying the complex phenomena emerging

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The increasing use of the credit and debit cards has converted them into important players in the world scene. In this market, the card providers deal with two different groups of users: consumers, that demand goods and merchants, that sell them. In addition, the consumers and the merchants demand electronic payment methods for their commercial transactions. The growing importance of these payment methods, explain the interest of economists and policy makers in understanding the different aspects of the market dynamics. The analytical models used for this purpose are built on representative players, whereas the large number of heterogeneous interactions among consumers, merchants and card providers is impossible to be taken into account. Nevertheless, we strongly believe that studying the complex phenomena emerging

Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash-using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.

NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the Finance and Economics Discussion Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers. Interchange Fees and Payment Card Networks: Economics, Industry

Preliminary version. Not for quotation.