Optimal Pricing of Payment Services When Cash is an Alternative

Payments are increasingly being made with payment cards rather than currency-this despite the fact that the operational cost of clearing a card payment usually exceeds the cost of transferring cash. In this paper we examine this puzzle through the lens of monetary theory. We consider the design of an optimal card-based payment system when cash is available as an alternative means of payment, and derive conditions under which cards will be preferred to cash. We …nd that a feature akin to the controversial "no-surcharge rule"may be necessary to ensure the viability of the card payment system. This rule, which is part of the contract between a card provider and a merchant, states that the merchant cannot charge a customer who pays by card more than a customer who pays by cash.