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October 18, 2007Optimal Pricing of Payment Services When Cash Is an Alternative

By Cyril Monnet and William RoberdsCyril Monnet and William Roberds

Abstract

Payments are increasingly being made with payment cards rather than currency–this despite the fact that the operational cost of clearing a card payment usually exceeds the cost of transferring cash. In this paper we examine this puzzle through the lens of monetary theory. We consider the design of an optimal card-based payment system when cash is available as an alternative means of payment, and derive conditions under which cards will be preferred to cash. We …nd that a feature akin to the controversial “no-surcharge rule”may be necessary to ensure the viability of the card payment system. This rule, which is part of the contract between a card provider and a merchant, states that the merchant cannot charge a customer who pays by card more than a customer who pays by cash. We thank audiences at the University of Rome Tor-Vergata, The Board of Governors, the Federal Reserve Banks of New York and Philadelphia, as well as Bob Hunt, Nobu Kiyotaki, Antoine Martin, Jamie McAndrews, Steve Williamson, and Randy Wright for comments and suggestions. The views expressed in the paper are not necessarily those of the Federal Reserve Bank of Philadelphia, the Federal Reserve Bank of Atlanta, or the Federal Reserve System. This paper is available free of charge at www.philadelphiafed.org/econ/wps/index.html 1

Year: 2007
OAI identifier: oai:CiteSeerX.psu:10.1.1.412.7930
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