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Price differentiation and menu costs in credit card payments

Marcos Valli Jorge (Department of Banking Operations and Payments System, Central Bank of Brazil, Brasilia, Brazil)
Wilfredo Leiva Maldonado (Graduate School of Economics, Catholic University of Brasilia, Brasilia, Brazil)

Journal of Economic Studies

ISSN: 0144-3585

Article publication date: 9 May 2016

Abstract

Purpose

The purpose of this paper is to model a credit card market where the retailers may charge differential prices depending on the instrument of payment used by the consumer. According to the research agenda proposed by Rochet and Wright (2010), the authors find conditions for the existence of differential prices equilibrium and analyze the effects of that price differentiation on the consumer’s welfare.

Design/methodology/approach

This is done when the consumer has also the store credit as an alternative of payment. The equilibrium prices are computed assuming a Hotelling competition among retailers in both scenarios, when the cost of the store credit provided by the retailer is greater than that provided by the credit card and vice versa.

Findings

From this, the authors prove that the average price under the price differentiation is lower than the single price under the no-surcharge rule; nevertheless, the retailer’s margins remain the same in both situations. Furthermore, some cross-subsidies are expunged when price differentiation is allowed. The authors also conclude that the consumers’ welfare is greater when the no-surcharge rule is abolished. Finally, if the retailers face menu costs whenever they differentiate prices, the authors provide sufficient conditions for differential prices remain as equilibrium.

Practical implications

This is an important input for discussions among regulators and players of the credit card market.

Originality/value

From the analysis the authors can conclude that price differentiation, according to the instrument of payment, is a welfare improving policy. The authors explicitly determine the average price in that setting and the differentiated prices even in presence of costs that arise from price differentiation. The obtained theoretical results can be used as an input for econometric modeling purposes.

Keywords

Acknowledgements

JEL Classification — L11, E42, G18

Citation

Jorge, M.V. and Maldonado, W.L. (2016), "Price differentiation and menu costs in credit card payments", Journal of Economic Studies, Vol. 43 No. 2, pp. 178-202. https://doi.org/10.1108/JES-08-2014-0152

Publisher

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Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited