By Oz Shy and Zhu Wang
December 2008
RWP 08-13
Research Division
Federal Reserve Bank of Kansas City

This paper explains why payment card companies charge consumers and merchants fees which are proportional to the transaction values instead of charging a fixed per-transaction fee. Our theory shows that, even in the absence of any cost considerations, card companies earn much higher profit when they charge proportional fees. It is also shown that competition among merchants reduces card companies? gains from using proportional fees relative to a fixed per-transaction fee. Merchants are found to be the losers from proportional fees whereas consumer and social welfare are invariant with respect to the two types of fees.