Are Sellers Free to Choose? An Analysis of the Interchange Fee

The paper presents a model of competition between cash and cards, with the card scheme based on the interchange fee. Merchants compete to attract consumers and, unlike previous papers, they compete on a Salop set-up so to emphasize the role played by network externalities. We find that for some levels of the interchange fee incomplete card acceptance by merchants is an equilibrium, while when the interchange fee is too large merchants opt out of card acceptance. However, if opting out is not a costless option there exists a stable “lock-in equilibrium ” in which merchants get locked into card acceptance. This happens when buyers face some cost for switching back to cash, which in turn has crucial implications on the level of the privately set interchange fee