Shrouded Transaction Costs∗

The proliferation of new payment methods on the Internet rekindles the old and unsettled debate about merchants’ incentive and ability to differentiate price according to payment choice. This paper develops an imperfect-information framework for the analysis of platform and social regulation of card surcharging and cash discounting. It makes three main contributions. First, it identifies the conditions under which concerns about missed sales induce merchants to perceive that they must take the card. Second, it derives a set of predictions about cash discounts, card surcharges and platform fees that match, and shed light on existing evidence. Finally, it studies regulation when surcharging is allowed, showing that (i) capping merchant fees reduces welfare if surcharges are unconstrained, (ii) recent reforms to cap surcharges at or above merchant cost ignore the merchant’s benefit from card payments and are accordingly too lenient; indeed surcharges should be banned when the merchant fee is regulated optimally.