Credit Card Acceptance, Product Quality and Merchant Fees

This paper explores a reason why retailers pay such large merchant fees to credit card issuers. Credit cards as media of exchange are introduced to a New Monetarist model in which exchange occurs in alternating centralized and decentralized markets. Sellers who exert high (low) effort produce a good with a high (low) probability of being high quality. The quality of the good is revealed only after trade. Buyers who use credit cards commit to repay the purchase price of the good to the card issuer in the next period. If the good is of low quality, the issuer stops payment to the seller and the buyer is not charged. Sellers who exert high effort, price goods to encourage credit card sales and to establish credibility. Thus a benefit offered to buyers can then be used by the credit card network to support charging sellers high merchant fees. JEL Classification: E42, D82