We estimate how demand for credit card transacting, borrowing, and late payment responds to the interest rate and late payment fee. We find that lower rates increase borrowing and lower fees increase late payments. Prime cardholders demand for all services is decreasing in any price. In contrast, subprime cardholders borrow less when fees drop, a response consistent with models of limited attention. We calculate that a 2 percentage point rise in the Federal Funds rate decreases borrowing by 16 percent, or $130 billion, that this effect is greater in higher income communities, and that it exhibits geographic agglomeration.
Considering markets with non-pivotal buyers we analyze the anti-competitive effects of breakup fees used by an incumbent facing a more efficient entrant in the future. Buyers differ in their intrinsic switching costs. Breakup fees are profitably used to foreclose entry, regardless of the entrant’s efficiency advantage or level of switching costs. Banning breakup fees is beneficial to consumers and enhances the total welfare unless the entrant’s efficiency is close to the incumbent’s. Inefficient foreclosure arises not because of rent shifting from the entrant, but because the incumbent uses the long-term contract to manipulate consumers’ expected surplus from not signing it.
|Publication Nr.||15-02 (R1)|
The LeChatelier-Samuelson principle states that as a reaction to a shock, an agent's short-run adjustment of an action is smaller than the long-run adjustment of that action when the other related actions can also be adjusted. We extend the principle to strategic environments and define long run as an adjustment that also includes other players adjusting their strategies. We show that the principle holds for both idiosyncratic shocks (affecting only one player's action directly) and common shocks in supermodular games, only for idiosyncratic shocks in submodular games if the players' payoffs depend only on their own strategies and the sum of the rivals' strategies (for example, homogeneous Cournot oligopoly), and only for idiosyncratic shocks in other games of strategic substitutes or heterogeneity satisfying Morishima Conditions. We argue that the principle might also explain the empirical findings of overshifting of cost and unit tax by multiproduct firms.
|Publication Nr.||15-03 (R1)|
This article summarizes the literature on two-sided payment card markets. The general conclusion is that interchange fees can help internalize the complementarity between services on both sides of the market but private platforms set too high interchange fees from a social welfare perspective. Private platforms' price structure is distorted in favor of buyers for several reasons: asymmetric choices between buyers and merchants, merchant internalization and/or platform competition. Furthermore, market power of platforms leads to higher total user prices similar to the case of one-sided markets. Platform competition can help to correct for such market power distortions but may exacerbate the price structure distortions. It is shown that full efficiency in the industry cannot be achieved through regulating the interchange fee. This is because the interchange fee affects only the allocation of the total user price between buyers and sellers. The first-best efficiency also requires a lower total price level due to positive externalities between the two sides. A measure to test whether interchange fees are excessive has been proposed but this measure may be imperfect.
The effects of interest rate changes and add-on fee regulation on consumer behavior in the U.S. credit card market
We estimate the effects of changes in interest rates and late payment fees on consumers' demand for credit card purchases, borrowing, and late payment. We find that consumers are responsive to interest rates as well as to the late payment fee in all three dimensions of usage. Subprime consumers' demand for each service is more sensitive to interest rates than prime consumers'. However, prime consumers' demand for borrowing or late payment is more sensitive to late payment fee than subprime consumers' respective demand. Our estimates suggest that the cap imposed on late payment fees by the CARD Act (keeping everything else equal) does not reduce issuers' revenue: the losses from reduced late fees are more than compensated by the gains from interest rates and interchange fees collected from raised credit card borrowing and purchases. We also illustrate that a hypothetical one-percentage-point rise in the Federal Funds rate lowers credit card borrowing by about 9 percent while keeping purchasing behavior virtually unchanged.
The payment card industry is subject to various price regulations. This paper provides a framework to assess how banks would react to a (hypothetical) card fee regulation and what the resulting effect would be on the consumer and merchant welfare. We model how consumers and merchants interact through the debit card, and how banks account for this interaction in setting card fees to consumers and merchants. Our application is the national debit card scheme in Norway, BankAxept. Using bank- and county-level data on the value of deposit accounts, various fees for consumers and merchants we estimate consumers' (debit card issuing) and merchants' (acquiring) bank choice. We also estimate cardholders' demand for card usage by combining bank- and county-level data on card usage volumes and fees with individual-level survey data on point of sale payment choices. Using the demand estimates we do counterfactuals to analyze the welfare effects of hypothetical fee regulations and introducing an interchange fee in the debit card scheme.
We show that a monopolist's problem of optimal advance selling strategy can be mathematically transformed into a problem of optimal bundling strategy if four conditions hold: i. consumers and the firm agree on the probability of the states occurring, ii. the firm pre-commits to the spot prices to be charged in the advance selling stage, iii. consumers are risk-neutral, and iv. consumers and the firm do not have time preferences or when they do have time preferences, they discount future at the same rate. The result allows both researchers and practitioners to apply the insights from the well-developed vast literature on bundling to advance selling problems. In particular, we show that advance selling is more profitable than spot selling when consumer valuations across the states are independent or negatively dependent or positively dependent up to a point. We furthermore illustrate the effect of advance selling on the spot prices and consumer welfare: When the firm offers advance selling discounts, it sets higher spot prices, so consumers who do not buy in advance are worse off due to the firm offering advance selling discounts. We extend our analysis to the cases of more than two states and competition only in one of the states. We also show how advance selling can be used as an entry deterrence strategy.
This paper analyzes the strategic use of bilateral supply contracts in sequential negotiations between one manufacturer and two differentiated retailers. Allowing for general contracts and retail bargaining power, I show that the first contracting parties have incentives to manipulate their contract to shift rent from the second contracting retailer and these incentives distort the industry profit away from the fully integrated monopoly outcome. To avoid such distortion, the first contracting parties may prefer to sign a contract which has no commitment power and can be renegotiated from scratch should the manufacturer fail in its subsequent negotiation with the second retailer. Renegotiation from scratch induces the first contracting parties to implement the monopoly prices and might enable them to capture the maximized industry profit. A slotting fee, an up-front fee paid by the manufacturer to the first retailer, and a menu of tariff-quantity pairs are sufficient contracts to implement the monopoly outcome. These results do not depend on the type of retail competition, the level of differentiation between the retailers, the order of sequential negotiations, the level of asymmetry between the retailers in terms of their bargaining power vis-à-vis the manufacturer or their profitability in exclusive dealing.
This paper analyzes the welfare implications of buyer mergers, which are mergers between downstream firms from different markets. We focus on the interaction between the merger's effects on downstream efficiency and on buyer power in a setup where one manufacturer with a non-linear cost function sells to two locally competitive retail markets. We show that size discounts for the merged entity has no impact on consumer prices or on smaller retailers, unless the merger affects the downstream efficiency of the merging parties. When the upstream cost function is convex, we find that there are "waterbed effects," that is, each small retailer pays a higher average tariff if a buyer merger improves downstream efficiency. We obtain the opposite results, "anti-waterbed effects," if the merger is inefficient. When the cost function is concave, there are only anti-waterbed effects. In each retail market, the merger decreases the final price if and only if it improves the efficiency of the merging parties, regardless of its impact on the average tariff of small retailers.
We examine a multinational firm which has a decreasing marginal cost, and the optimal sales tax policies of the regions where that firm operates. We show that the regions set higher sales taxes than those given by a cooperative equilibrium. Each region fails to fully internalize the effects of its tax level on another region's welfare and the incentives for that region's authority. Exponential cost functions which exhibit economies of scale (for example Cobb-Douglas) and linear demand functions satisfy our assumptions. Our results suggest the need to coordinate sales tax levels between countries and between smaller entities, like states in the United States. Smaller regions benefit more from such coordination. Lowering sales taxes in each region increases welfare for all regions, profits for firms, and consumer welfare.
Payment card networks, such as Visa, require merchants' banks to pay substantial "interchange" fees to cardholders' banks, on a per transaction basis. This paper shows that a network's profit-maximizing fee induces an inefficient price structure, over-subsidizing card usage and over-taxing merchants. In contrast to the literature we show that this distortion is systematic and arises from the fact that consumers make two distinct decisions (membership and usage) whereas merchants make only one (membership). These findings are robust to competition for cardholders and/or for merchants, network competition, and strategic card acceptance to attract consumers.
An earlier version of this working paper appeared in the European Central Bank Working Paper Series (No. 1139).
The common belief is that buyers’ “countervailing power” is good for consumers since it lowers purchasing costs of retailers, and thus lowers retail prices. However, when retailers are asymmetric, lowering the purchasing price for a powerful retailer might lead to higher purchasing prices for weak retailers, so called “waterbed effects”. This paper analyzes the validity of these antitrust concerns with a dominant retailer facing competitive fringe firms, where the fringe firms are offered a wholesale price by the supplier, whereas the dominant retailer negotiates its contract terms including a unit price and a fixed fee. When the dominant retailer’s bargaining power is significant, we show that, the supplier allows the less efficient fringe firms to be active to increase its outside option and thereby to capture more rent from the dominant retailer, at the expense of lowering their bilateral profit. Moreover, the supplier offers a lower wholesale price to the fringe if the dominant retailer’s bargaining power increases, that is, there are anti-waterbed effects. The equilibrium retail price might increase in the dominant firm’s bargaining power. This would be the case if the fringe firms’ supply is sufficiently concave, that is, if the fringe firms become less inefficient when they sell more.