Tuesday, February 3, 2009

The True Cost of Credit

A new website “The True Cost of Credit” created by one of Steve Levitt’s former students, examines the costs associated with using your credit card when making a purchase. As the data here suggests the fee charged to sellers can range from 18% to 1% depending on the purchase price. Since there is a per transaction cost charge, the lower the price of the good the higher the percentage the transaction fee as a total of purchase price.

Still as the website points out at 2.7% per ($300 flight), Southwest spends over 200 million dollars . This is more than Southwest earned in the third quarter of last year (a decent year for profits).

But a couple of questions arise, why does Southwest take credit cards? Because it is cheaper than hiring someone to collect all the cash. But why not give discounts to those who use debit cards with lower transaction fees? Because the credit card companies have made it illegal to do so.
So final question do credit cards improve transaction costs or make them worse? There are few credit cards, and Visa and Mastercard have essentially duopoly with some competition. Since the two cards are so wide spread merchants have to accept or they might lose business to competitors. In fact the two companies were sued and recently settled with American Express (link) over claims they tried to prevent competition.

So credit cards are most likely good as long as there is some competition between companies. So maybe we should be glad this website on the true cost of credit is run by a firm trying to lower transactions costs through the use of debit cards.

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