Who Pays for Credit Cards?

Chakravorti and To construct a two-period model to study the interactions among consumers, merchants, and a card issuer. The model yields the following results. First, if the issuer's cost of funds is not too high and the merchant's profit margin is sufficiently high, in every equilibrium of our model the issuer extends credit to qualified consumers, merchants accept credit cards and consumers face a positive probability of default. Second, the issuer's ability to charge higher merchant discount fees depends on the number of customers gained when credit cards are accepted. Thus, credit cards exhibit characteristics of network goods. Third, each merchant faces a prisoner's dilemma where each independently chooses to accept credit cards, however, all merchants' two-period profits are reduced because of intertemporal business stealing across industries.

Payment cards continue to replace cash and checks in advanced economies. Along with the growth of payment card transactions has come greater scrutiny by public authorities of certain payment network rules along with the level of certain fees. Chakravorti reviews the growing payment card literature and discusses the impact of several regulatory interventions on card adoption, usage, and social welfare.

Chakravorti and Roson construct a model to study competing payment networks, where networks offer differentiated products in terms of benefits to consumers and merchants. We study market equilibria for a variety of market structures: duopolistic competition and cartel, symmetric and asymmetric networks, and alternative assumptions about consumer preferences. We find that competition unambiguously increases consumer and merchant welfare. We extend this analysis to competition among payment networks providing different payment instruments and find similar results.