Do Premium Payment Methods Increase Effective Retail Prices?

Abstract

In this paper, we determine how premium payment methods impact effective prices (prices that include any consumer payment rewards). This question is fundamentally related to policy, and we provide a robust answer by considering how a variety of retail market structures are impacted by multiple payment methods. We find that, with a no-surcharge rule applied to the premium payment method, effective prices are often higher across all payment methods. In this case, the no-surcharge rule protects a double marginalization effect where the premium payment method inserts an additional margin that harms all consumers and all merchants. We show that this loss in welfare can be rectified by allowing merchant surcharging across payment methods. Our results are robust across merchant market structures, suggesting that protected premium payment methods are generally harmful, except for the payment industry.