Consumer Choice and Merchant Acceptance of Payment Media
De Nederlandsche Bank (Dutch Central Bank)
The Clearing House
November, 28 2008
FRB of Chicago Working Paper No. 2008-11
We study the ability of banks and merchants to influence the consumer's payment instrument choice. Consumers participate in payment card networks to insure themselves against three types of shocks - income, theft, and their merchant match. Merchants choose which payment instruments to accept based on their production costs and increased profit opportunities. Our key results can be summarized as follows. The structure of prices is determined by the level of the bank's cost to provide payment services including the level of aggregate credit loss, the probability of theft, and the timing of income flows. We also identify equilibria where the bank finds it profitable to offer one or both payment cards. Our model predicts that when merchants are restricted to charging a uniform price for goods that they sell, the bank benefits while consumers and merchants are worse off. Finally, we compare welfare-maximizing price structures to those that result from the bank's profit-maximizing price structure.
Number of Pages in PDF File: 47
Keywords: Retail Financial Services, Network Effects, Social Welfare, Multihoming
JEL Classification: L11, G21, D53
Date posted: November 29, 2008
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