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CREDIT CARDS IN THE U.S. ECONOMY:
Their Impact on Costs, Prices, and Retail Sales
A Study by the Board of Governors of the Federal Reserve System

CREDIT CARDS IN THE U.S. ECONOMY:
Their Impact on Costs, Prices, and Retail Sales
A Study by the Board of Governors of the Federal Reserve System
Submitted to the Committee of Banking, Housing, and Urban Affairs
of the United States Senate
and
the Committee on Banking, Finance and Urban Affairs
of the United States House of Representatives
Pursuant to Section 202 of the Cash Discount Act of 1981

July 27, 1983

CREDIT CARDS IN THE U.S. ECONOMY:
THEIR IMPACT ON COSTS, PRICES, AND RETAIL SALES

CONTENTS

PAGE

Introduction and Summary

1.1.
1.2.
1.3.

1
2

Scope of Study
Origin of Study
Summary

Economic Characteristics of Credit Card Plans

2.1.
2.2.
2.3.
2.4.
2.5.

10
13
16
17
18

Gasoline Company Credit Cards
Bank Credit Cards
General Purpose Credit Cards
Retail Store Credit Cards
Other Credit Cards

Impact of Credit Cards on Consumer Spending

3.1.
3.2.

20
22
23
28

Patterns of Credit Card Usage
Impact of Credit Cards on Expenditures
Microeconomic evidence
Macroeconomic evidence

Effect of Credit Card Transactions on Costs of Retailers

4.1.
4.2.

32
36
38
47

The Incentive to Engage in Credit CardTransactions
Costs to Retailers of Credit CardTransactions
Empirical studies
1983 survey of retailers

Effect of Credit Cards on Prices of Goods and Services

5.1.

59
60
61
63

5.2.

Retailer Pricing Behavior: MicroeconomicPerspective
Magnitude of price effect
Price determination and credit surcharges
Competition in retailing
Impact of Credit Cards Use on Price Movements
and Economic Activity

CONTENTS (cont.)

PAGE

Separate Pricing of Credit Card Services and Retail Products

6.1.
6.2.
6.3.

69
74
78
78
82
86
90

Cost Recovery Through Financing Revenues
Two-Tier Pricing Structure
Buyer and Seller Attitudes to Discounts
Survey of gasoline purchases
Survey of hypothetical reactions to discounts
Independent study of feasible discounts
Results of retailer poll on two-tier pricing

Bibliography
Appendix A

Text of Cash Discount Act of 1981

Appendix B

Federal Reserve Surveys on Credit Cards and
Related Materials

Appendix C

Hypothetical Example of Two-Tier Pricing of Gasoline

CREDIT CARDS IN THE U.S. ECONOMY:
THEIR IMPACT ON COSTS, PRICES, AND RETAIL SALES

INTRODUCTION AND SUMMARY
By at least the beginning of the 1970s the personal credit card

had become a fixture in the nation's economy.

Card use had spread rapidly

after World War II, and accelerated with the development of the bank credit
card in the late 1950s.

Today almost 600 million credit card accounts exist

in the United States, and seven out of ten households possess at least one
credit card.

Outstanding balances on credit card accounts total more than

$75 billion.
Despite the widespread use of credit cards, opinion has been
divided on their economic significance.

In response to a Congressional

request for a report on the economic impact of credit cards— deemed necessary
to evaluate a law that encouraged the offering of price discounts for payment
by cash— this study examines the impact of credit cards on the costs that
merchants and creditors incur, on the pricing of goods sold by retailers,
and on the volume of retail sales.

The Congress asked for information on

these issues to help ascertain whether and to what extent credit card users
are subsidized by cash customers when both pay the same prices for goods and
services.
1.1.

Scope of Study
While some background is provided (in Chapter 2) on the history,

characteristics, and use of different types of credit cards, the primary
focus of the study is on the costs to retailers associated with credit card
transactions, compared with the costs of cash and check transactions, and on
the question of how credit cards affect the sales of retailers— topics that

-2were of central concern in the discussions that led to the study request.
The study also seeks to provide the Congress with up-to-date information on
the prevalence of discount-for-cash programs, and current attitudes of both
retailers and consumers toward such programs.

The study provides no recom

mendations regarding legislation to promote discounts for cash or surcharges
for credit, in view of the Congressional request for an informational rather
than an advisory study.
The report draws upon existing studies, where applicable, and also
presents findings of special surveys of households and retailers undertaken
expressly for this report.

The Federal Reserve Board sponsored questions

about consumer response to discounts for cash on two regular household
surveys conducted by the Survey Research Center at the University of Michigan.
The Board also commissioned a survey of retail organizations about their
perceptions of relative costs of cash, check, and credit card transactions,
and on their practices and views concerning the offering of price discounts
to customers who pay cash.
1.2.

Origin of Study
In 1974, the Congress amended the Consumer Credit Protection Act

(more commonly referred to as the Truth in Lending Act) to encourage merchants
to offer discounts to customers who pay for purchases with cash instead of
credit cards.

The amendments, contained in the Fair Credit Billing Act of

1974, were based on a conviction that credit card transactions were more
costly for merchants to handle than were cash transactions.

Recognizing

also that in the long run selling costs must be recovered in the prices that
merchants charge, the Congress concluded that cash buyers were subsidizing
credit buyers in the customary situation where both faced an identical retail

-3price for a given item at a given store.

The amendments sought to encourage

discounts by (1) prohibiting card issuers from contractually forbidding
merchants to offer cash discounts and (2) exempting cash discounts of up to
five percent from the requirement of disclosure as finance charges under
federal law.^

The Federal Reserve Board was to administer these provisions

as part of its general responsibilities under the Truth in Lending Act.
In implementing the exemption of cash discounts from treatment as
finance charges under the Truth in Lending Act, the Board encountered the
question as to whether the Congress intended this special treatment to apply
to both discount and surcharge pricing systems.

The Board requested guidance

from Congress on its legislative intent, and the Congress responded in 1976
by specifically defining the terras "discount" and "surcharge" as, respectively,
a reduction from and an addition to the "regular price."

"Regular price" was

not defined, but the Congress clearly specified that a discount was not
equivalent to a surcharge, and prohibited the imposition of surcharges until
February 27, 1979.

The particular mechanics of establishing a two-tier price

system had to involve discounts from the credit price for cash customers
rather than surcharges to the cash price for credit customers.

In addition,

the 1976 amendments provided that discounts offered in accordance with the
act and regulation would not be considered credit charges under any state
usury or disclosure laws.

The surcharge prohibition was extended in 1978

for an additional two years, until February 27, 1981, without change.
1. The Truth in Lending Act requires extenders of credit to provide borrowers
with information on the cost of credit expressed on a standardized basis to
facilitate comparison shopping among creditors. This act and Federal Reserve
regulations specify what should and should not be treated as a finance charge
in calculating the annual percentage rate to be disclosed.
In general, in
credit sale transactions any difference between the cash price and the credit
price is to be treated as a finance charge. Under these circumstances, es~
specially in light of state laws setting maximum interest rates on consumer
credit, merchants and card issuers were reluctant to price goods separately for
sale by cash or by credit.

-4In 1981 Congress further amended the cash discount provisions in
the Truth in Lending Act and once again extended the surcharge prohibition.
The principal amendments (1) eliminated the 5 percent limit on discounts that
were exempt from treatment as a finance charge, thus authorizing unlimited
discounts, and (2) removed language that directed the Board to issue regula
tions concerning the offering of discounts.

The surcharge prohibition was

extended until Februry 27, 1984, but only after considerable debate and the
addition to the Act of a requirement that a study be prepared by the Federal
Reserve Board concerning credit cards.1
While the primary focus of decision in early 1984 apparently was to
be whether to continue or to remove the surcharge prohibition, the Congress
requested a study that would go beyond a comparison of surcharges and dis
counts to a fundamental examination of the economic merits of two-tier
pricing— by whatever mechanism achieved.

It was remarked several times in

the Senate floor discussion that relatively little evidence had been put
forth to substantiate the belief that credit transactions were more costly to
retailers than cash transactions; that, in fact, the main study of credit
cards familiar to the senators— a 1968 Federal Reserve study— had found that
credit cards exerted little upward pressure on costs of retailers.2
1. For the currently effective amendments to the Truth in Lending Act regarding
discounts for cash, see:
15 U.S.C. §1666f (1982) (Pub. L. No. 90-321, Title
1, §167, as added Pub. L. No. 93-495, Title III, §306, October 28, 1974, and
amended Pub. L. No. 94-222, §3(c)(l), February 27, 1976, 90 Stat. 197; Pub.
L. No. 97-25, Title I, §101, July 27, 1981, 95 Stat. 144.) The text of the
Cash Discount Act of 1981 is provided in Appendix A.
2. Board of Governors of the Federal Reserve System, Bank Credit Cards and
Check Credit Plans (Board of Governors, 1968), pp. 58-59. This conclusion was
based in considerable part on the costs to retailers stemming from bank credit
cards compared with the operating costs of store-card plans.
If bank-card
transactions primarily substitute for store-card transactions, a retailer
would likely experience no change (or some decline) in costs.
The 1968 study
noted that "upward pressure on prices would arise from any massive shift of
cash customers to the use of credit cards if there were no offsetting increase
in the volume of transactions," but found little evidence that such a shift
from cash was likely.

-5Thus, under Title II of the Cash Discount Act of 1981, the present
study was commissioned to provide the Congress with a report on what is
known about the impact of credit cards on the economy, particularly with
regard to the costs incurred by retailers and the pricing of goods and
services.

The specific instruction from Congress was as follows:
"the Board of Governors of the Federal Reserve System shall
prepare a study, on the basis of a review and analysis of
such data and studies as it finds appropriate...on the
effect of charge card transactions upon card issuers,
merchants, and consumers, including to the extent possible—
(1) the effects of charge card transactions on
retail sales;
(2) the effect of charge card usage on consumers
and on merchants, including the effects on merchant
cost; and
(3) the effect of charge card usage on the pricing
of goods and services, with a comparison of the costs
resulting from payment by (A) currency and coin,
(B) by personal check or similar instrument, (C) by
in-house credit plans, and (D) by charge card."

1.3.

Summary
As observed above, the fundamental thesis underlying the Cash

Discount Act is that credit card transactions are more costly to retailers
than cash or check transactions, and that the higher costs of credit cards
are incorporated in the prices of goods and services paid by all customers,
resulting in a subsidy of credit buyers by cash purchasers.
The most basic challenge to this view would be the assertion that,
properly measured, transactions costs for credit cards do not differ from
other means of payment, or that the magnitude of difference is negligible.
Another counter-argument sometimes proposed to the subsidy thesis is that
credit cards generate incremental sales for retailers, so that the additional
profits thereby attributable to cards eliminate any need to recover the cost

-6of credit cards in prices of goods and services.

The following chapters

discuss these issues, and also examine the current practices and attitudes
of retailers toward offering discounts for cash.
Following a brief overview in Chapter 2 describing the types of
credit cards available and the incidence of their use among households,
Chapter 3 examines the broad question of the impact of credit cards on sales
of retailers.

Many observers would argue that because consumers are enabled

by credit cards to spend beyond the immediate limits of cash or checking
account balances, they are more likely to make ill-considered purchases and,
in general, to spend more and save less than they would in the absence of
credit cards.
This idea was examined in two ways:

first, through a survey of

households on "impulse" purchases transacted by credit cards; and second, by
a review of available research on the link between credit cards and aggregate
spending, on the grounds that any broad increase in spending induced by
credit cards would be expected to boost aggregate consumption and to reduce
the aggregate saving rate.

However, neither the household survey nor the

macroeconomic studies suggest that any strong, consistent relationship
exists between credit cards and incremental sales among retailers as a group.1
The survey found that many unplanned purchases were transacted by cash, and
that many of those transacted through credit cards would likely have been
undertaken even without access to a credit card.

The limited amount of

macroeconomic research available has failed to establish any measurable
impact of credit cards on the aggregate saving rate.
1. Whether card-honoring retailers attract sales from other retailers who
don't accept credit cards is treated as a minor issue, in view of the wide
spread acceptance of credit cards. Unless industry-wide sales are increased,
gains and losses from credit card sales will net out among retailers, yielding
no net additional revenues to offset the higher costs of credit cards.

-7Chapter 4 examines the costs associated with credit cards and other
means of payment, and summarizes a number of relevant studies.

It also

reports on the results of a survey of retailers conducted this year concerning
their perceptions of the relative costs of credit cards, cash, and checks.
The weight of the evidence from the survey and other studies is that total
net costs to retailers associated with credit cards— including point-of-sale,
security-related, and financial costs— are in fact higher than for other
types of transactions, typically by about 2 to 3 percent of the transaction
amount, a figure which roughly corresponds to the average factoring or
servicing fee paid by merchants to issuers of third-party credit cards (or
the net credit department deficits of retailers that issue their own credit
cards).

For most retailers, the costs of check transactions appear to be

smaller than for credit cards, and either about the same or larger than for
cash.

Large retailers were more likely than small retailers to rate both

checks and credit cards as more costly than cash.
In Chapter 5, the issue of whether the higher costs of credit cards
are included in retail prices is discussed.

From a microeconomic perspective,

it is concluded that prices in the long run would reflect all such costs
that were not recovered directly from credit card users, but that the size
of the price effect would be small.

In total, the need to cover credit-

related costs would likely boost the price of a given item by less than 1 per
cent. This minimal impact owes in part to the relatively small share of
sales transacted by credit cards (around 15 percent through third-party cards
in the areas of general merchandising under study).
From a macroeconomic perspective, credit cards could potentially
affect economic activity by altering the aggregate propensity to consume
and/or the transactions demand for money.

Some impact on the equilibrium

-8level of prices during a period of adjustment to the introduction of credit
cards is held possible, but available evidence suggests that such an effect
would be small and mostly irrelevant to the long-run processes of economic
growth or inflation.
From Chapters 3 through 5, it can be concluded that credit card
transactions cost most retailers more than cash (or check) transactions, and
that this cost is not offset by higher retail sales volume, but is reflected
in the level of prices.

As a result it can be said that cash buyers, at least

to some extent, subsidize credit card users by paying identical prices.
Chapter 6 examines two possible methods of minimizing the subsidy:
(1) removal of government-imposed artificial barriers to coverage of credit
card costs via finance charges and other user fees, and (2) establishment of
a two-tier price structure involving discounts for cash or surcharges for
credit.
Because of revisions in state usury laws and other statutes, card
issuers have been in position to shift more of the cost of credit cards onto
users recently.

Adoption of two-tier pricing appears feasible for most

retailers only if they simultaneously raise the base price from which dis
counts would be calculated, so that the "new" credit price is above— and
the discounted cash price only somewhat below— the "old" single price.^
This conclusion is based on results from surveys of consumer reaction to
actual two-tier pricing of gasoline and to hypothetical discounts for cash
on durable goods and clothing, as well as implications from the findings on
costs in Chapter 4.
A polling of retailers on their current practices and attitudes
toward discounts for cash, reported in Chapter 6, found that in the spring of
1. Two-tier pricing through surcharges for credit would ordinarily result in
the same structure of credit and cash price as under a discount-for-cash
approach.

-91983 cash discounts were typically the exception rather than the rule for
types of business likely to accept credit cards in addition to other means of
payment.

About 25 percent of gasoline stations and 6 percent of other retailers

offered discounts, with around 40 percent of all retailers surveyed describing
discounts for cash as "a good idea."

About three out of every ten retailers

thought that surcharges for credit constituted a better approach to two-tier
pricing than discounts for cash; 70 percent thought surcharges an inferior
approach.

-102.

ECONOMIC CHARACTERISTICS OF CREDIT CARD PLANS
Credit card plans in today's marketplace offer consumers a diverse

menu of financial services.

As background for the ensuing analysis, the

present chapter compares the services currently offered by five major types
of credit cards, the cost implications and pricing of these services, and
trends in the holding and use of each type of card.^
2.1.

Gasoline Company Credit Cards
Gasoline credit cards are "two-party" arrangements— credit cards

that are issued by a vendor for customers to use in making credit purchases
primarily or exclusively at the retail outlets of the issuing company.2
Most gasoline company credit card programs provide credit for a one-month
billing period with no provision for extending repayment over a longer period.
Some gasoline companies offer optional extended periods to pay for purchases
of more expensive items such as tires, batteries, or repairs.
As a result of the short repayment period, the gross expense to the
gasoline companies of financing these receivables is lower, relative to the
dollar volume of credit billings, than for credit card programs that offer
extended repayment terms.^

However, the rather low average amount of credit

purchases at gasoline stations implies that costs of processing credit card
transactions tend to be fairly high per dollar of credit sales.

Although

processing costs are subject to some degree of control, particularly through
1. For further discussion of holding and use of credit cards, see Thomas A.
Durkin and Gregory E. Elliehausen, 1977 Consumer Credit Survey (Board of
Governors of the Federal Reserve System, 1978).
2. Some gasoline company credit cards can be used to make purchases at sta
tions operating under different brand names. Also, accommodations and meals
at specified lodging establishments and restaurants can be charged on some
gasoline company credit cards.
3. An offsetting factor is the relatively low amount of finance charge revenue
generated by this type of credit card plan.

-11implementation of more efficient automated procedures that capture economies
of scale, financial costs are mainly determined by market conditions and are
largely beyond the control of credit card issuers.
Pricing of gasoline credit cards has consisted mainly of a finance
charge applied to past-due balances.

Thus, there has been no explicit charge

for credit services used by credit customers that pay in full within the
initial billing period.

In the past few years, however, some gasoline

companies have offered auto or travel clubs, for which membership fees are
charged, consisting of credit card plans combined with travel-related services.
Apart from this specialized development, no gasoline company has yet initiated
a cardholder fee for its regular credit card program.
Since late 1981, some gasoline companies have begun programs that
offer lower prices to customers who pay in cash rather than by credit card.
Dealers who choose to participate in these programs generally charge customers
about 3 to 5 cents per gallon less than the posted price if payment is made
in cash; as a result, all credit card users help to defray at least part of
the cost of providing credit card services.

Several gasoline companies have

also begun charging their dealers a handling fee— typically about 3 percent
of amounts due from customers— for processing credit card billings.
The proportion of families that holds one or more gasoline company
credit cards has remained stable, overall, in recent years at slightly above
one-third (table 2.1).

The dropoff in 1981 to 30 percent likely reflects

short-term adjustments resulting from the 1979-80 gasoline shortage and
associated price increases, as well as the temporary impact of the consumer
credit restraint program that was in effect during the first half of 1980.
Use of gasoline credit cards has followed a generally similar
pattern (table 2.2).

About one-third of families has used gasoline company

-12TABLE 2.1
CREDIT CARD HOLDING
(Families Holding Cards as Percent of All Families)
Year

Type of
Credit Card

1977

1978

1981

1982

Any

Gasoline

Bank

General purpose^
Retail store
Other2

n. a.

1. Travel and entertainment cards.
2. Includes airline cards, car-rental c.ards, and others not classified
elsewhere.
n.a.— not available
Source: Data collected for the Federal Reserve Board by the Survey Research
Center, University of Michigan
TABLE 2.2
CREDIT CARD USE
(Families Using Cards as Percent of All Families)
Type of
Credit Card

1982

n.a.

1977

Any

503

Gasoline

Bank
General purpose3
Retail store
Other2

Year
1978

1981

1971

n.a.

n. a .

1. Travel and entertainment cards.
2. Includes airline cards and car-rental cards.
3. Data for 1970.
n.a.— not available
Source:
1970 Survey of Consumer Finances, 1971-72 Surveys of Consumers, and
data collected for the Federal Reserve Board by the Survey Research
Center, University of Michigan.

-13credit cards since the early seventies.

Some indication of reduced usage

in 1981 likely reflects the aftereffects of gasoline shortages and government
policies to restrain certain types of credit use.
2.2.

Bank Credit Cards^
By contrast, bank credit cards are "third-party" arrangements in

which the company that provides the financial service has no affiliation
with the buyer or the seller of the goods and services purchased with the
credit card.

Bank credit cards offer highly flexible credit terms.

Customers

who can qualify for a fairly large credit limit— those who have a good credit
history and adequate income— can incur relatively large indebtedness on such
an account.

Also, by choosing to pay less than the entire balance, account

holders can stretch out repayments over an extended period of time.

Thus,

the bank credit card can be used to satisfy fairly large needs for immediate
credit, and— if desired— to scale repayments to available income.

Further

more, bank credit cards are widely accepted for purchases of a large variety
of goods and services, and can also be used to obtain cash at many financial
institutions.
The gross financing cost incurred by a typical bank credit card
issuer per dollar of credit billings likely exceeds that of most gasoline
credit card programs, since a lower proportion— slightly less than threefifths— of bank card customers usually pays the entire balance when billed.
Processing costs are lower relative to the volume of bank credit card billings,
owing to the larger average dollar amount of bank credit card transactions.1
1. Although the term "bank" credit card is commonly used, it obscures the
growing diversity of institutions and organizations offering such services.
"Bank" cards now are issued by finance companies (through commercial banks
that may be subsidiaries), savings and loan associations, and credit unions.
Some nonfinancial organizations such as the American Automobile Association
have made arrangements with commercial banks to issue bank credit cards to
members in the name of the organization.

-14Banks processing credit card receivables deduct a percentage of all
credit card billings— called a "merchant discount" fee— for handling credit
card slips submitted by the retailers.

In turn, card-issuing banks charge

other banks an "interchange" fee for clearing transactions billed to the
accounts of customers of the card-issuing bank.

Such fees help compensate

card-issuing institutions for expenses of record keeping, billing customers,
non-payment by customers, and fraudulent use of credit cards.
Customer pricing of bank credit cards has changed substantially
in recent years.

Before the mid-1970s, most banks relied entirely on a

finance charge on customer credit card balances that remained unpaid after
the initial billing period.

Recent changes in financial and regulatory

conditions have caused many banks to implement periodic fees for maintaining
customer credit card accounts.

As market interest rates increased during

the late 1970s, the costs of funding credit card services rose significantly.
Although faced with rising costs, banks in many states were unable to increase
revenue derived from finance charges because of binding statutory rate ceilings.
A related factor was the gradual phaseout of regulatory limitations
on deposit rates mandated by the Depository Institutions Deregulation and
Monetary Control Act of 1980.

The costs of funds acquired from bank customers

increased as banks began to pay higher rates to attract and retain savings
and time deposits, and as banks started to offer new transactions accounts
that— unlike regular checking accounts— paid interest on deposits.

Finally,

from March 1980 through early July 1980, the credit restraint program
administered by the Federal Reserve at the direction of President Carter
imposed a special deposit requirement that caused some banks and other credit
card issuers to experience additional costs of providing revolving credit.

-15To offset these cost pressures, many banks adopted periodic fees in
an effort to boost current revenues and to re-price credit card services on
a basis better suited to an environment in which customer deposit rates are
unrestricted.-*-

Some banks have pursued means of boosting revenues other than

through imposing periodic fees, such as charging for each transaction billed
to a credit card account and assessing penalties for late payments, for replace
ment of lost cards, or for balances that exceed credit limits.

Other banks

have increased merchant discount fees or customer finance charges, where com
petitive and regulatory conditions have permitted such action, or have started
charging interest from the date that transactions are posted to an account
rather than after an initial billing cycle.
A variant of the bank credit card offered by some institutions is
the so-called "gold card."

This specialized type of "premium" bank credit

card combines the features of the regular bank credit card with a larger credit
line and a package of additional services that may include accident insurance,
lost credit card service, hotel and car rental discounts, and free travelers
checks.

Fees charged cardholders for gold card services typically exceed the

range of fees on regular bank credit card accounts, but ordinarily are less
than the fees charged for general purpose (travel and entertainment) cards.
One-half of all families in the United States now holds one or more
bank credit cards, up from nearly two-fifths in 1977 (table 2.1).

The propor

tion of families holding a bank credit card has expanded continually, as
has the percentage of families that uses bank credit cards, which rose from
one-fifth in 1971 to nearly one-half in 1982 (table 2.2).1
1. As providers of "third-party" credit card services, issuers of bank credit
cards cannot fall back on profits from the sale of goods and services financed
with such credit cards to cover some costs of providing credit card services.

-162.3

General Purpose Credit Cards^
This type of third-party credit card is oriented toward more

affluent customers able to pay a larger annual membership fee for access to
premium credit card services.

Since higher income requirements must be met

to qualify for general purpose credit cards, an element of prestige may be
attached to carrying such cards as well as some presumption that cardholder
creditworthiness is less subject to question than with other credit cards.
Therefore, these programs appeal to customers who travel and/or entertain
frequently, for whom an easily accepted credit card with a relatively high
credit limit can be especially convenient.
A variety of ancillary services is typically offered as part of a
general purpose credit card package.

Travel accident insurance, discounts

on travelers checks, on hotel accommodations, and on car rental, and access
to check cashing or cash advances from company or affiliated offices or from
card-activated cash dispensers are examples of these additional services.
In addition to membership fees, card issuers also derive revenues
from merchant discount charges paid by retailers.

Another important feature

of general purpose credit cards is the requirement that balances be repaid
within 30 days after billing.

Thus, although the average balance for such

accounts may be large, credit remains outstanding for only a relatively
short period of time, so that gross financing costs incurred by the card
issuers are kept fairly low in relation to the volume of billings.
"Gold cards" for a select clientele were first developed as variants
of general purpose credit cards.

As with bank credit card plans that later

adopted this strategy, these gold card plans provide additional services and a
larger credit limit at a higher fee and with a more stringent income requirement.
1. Also frequently referred to as "travel and entertainment cards." Major
issuers of such credit cards include American Express, Carte Blanche, and
Diner's Club.

-17Gold cards also permit repayment of balances over an extended period, in
contrast to regular travel and entertainment cards that require payment
within 30 days of billing.
General purpose credit cards are held by almost 15 percent of
families, up sharply from only 8 percent in 1977 (table 2.1).

The percentage

of families that uses general purpose credit cards has almost doubled since
1977 (table 2.2).
2.4

Retail Store Credit Cards
Two-party credit cards issued by retail stores are the most widely

held and used type of credit card.

Over three-fifths of families in the

United States held some kind of retail store credit card in late 1982 (table
2.1), and most of these families used such cards to some extent (table 2.2).
Holding and use of retail store cards have continued to expand in recent
years, even though retail credit cards have long been available and despite
increasing competition from third-party credit cards, some of which now are
accepted by many leading department stores and specialty shops.
Retail store cards typically offer lower credit limits and have
less demanding credit qualification requirements in comparison with thirdparty credit cards.

Of course, use of retail credit cards is limited to the

variety of merchandise carried by the issuing merchant.

Retail revolving

credit plans usually provide customers the option of repaying over an extended
period of time.

Typically, three-fifths of retail credit card customers usually

pay the entire balance billed to their accounts, about the same proportion of
non-revolvers as is found with bank credit cards.
Retail credit card plans may be administered and financed either
"in-house" by the retailer or by an outside firm that contracts with the
retailer to furnish "private label" credit card services.

All costs of

-18operating in-house credit card plans are borne directly by the retailer.
In-house credit card plans derive revenues from finance charges on credit
card balances that are not repaid before the end of a billing cycle.

Retailers

have not adopted the strategy followed by many commercial banks of charging
periodic fees for access to credit card services.

To some extent, retail

establishments may have more leeway than financial institutions in pricing
credit card services, since— except under conditions of intense price
competition— some costs of providing credit cards may be recouped from profits
on sales of merchandise.
Except for the fact that credit cards bearing the retailer's name
are issued to its customers in both cases, private label and in-house credit
card plans differ in most respects.

Indeed, private label retailer credit

card plans more closely resemble bank credit card programs.

A bank or a

finance company vendor agrees to conduct and finance a credit card program
for the retailer, in return for a fee analogous to the merchant discount fee
paid to banks by retailers who accept bank credit cards.

Private label

credit card plans are used mainly by small- and medium-sized retail firms
that prefer to purchase the managerial experience and the legal and financial
resources of a large financial organization instead of bearing the expense
of developing such capabilities internally.
2.5

Other Credit Cards
The remaining category of credit cards used by consumers is highly

specialized and appears to be growing slowly.

Such credit cards mainly are

issued by some airlines and car-rental firms.

About 7 percent of families

held this type of credit card in 1981 (table 2.1) and about 5 percent used it
to some extent (table 2.2).

-19The larger car-rental firms offer credit card accounts that have no
annual fees and require full payment by the end of each billing period.
companies provide credit card accounts only for businesses.

Some

A number of

major airlines provide credit card plans that are available to individuals,
permit extended payments, and have no periodic fees.

In addition, many

carriers accept Universal Air Travel Plan credit cards, although this account
is mainly available for business travel and requires full payment during
each billing period.
The revenue, cost, and usage characteristics associated with the
major types of credit card plans reviewed in this chapter reflect efforts
by card issuers to provide financial services that appeal to customers with
varied financial requirements.

To simplify the discussion in the following

chapters, the analysis distinguishes mainly between third-party credit cards
and in-house credit cards, with some separate attention to gasoline company
credit cards.

In the next chapter, in addition, the contrast is sharpened

between transactions use— a feature of all credit cards— and longer-term
borrowing, which occurs only with credit cards that permit extended payment
terms.

-20-

3.
3.1.

IMPACT OF CREDIT CARDS ON CONSUMER SPENDING
Patterns of Credit Card Usage

Approximately two-thirds of the households in the United States hold
credit cards of some type, as noted in Chapter 2, but the use made of these
credit cards varies substantially among households.

Two basic contrasting

patterns of usage may be described as "convenience use" for transactions pur
poses and "installment use" for borrowing activity.
Credit cards enable their holders to make purchases on a deferred
payment basis.

To some card holders, especially "convenience users," the

significance of this payment deferral mechanism is that it permits them to
carry smaller amounts of cash than might otherwise be necessary (or to obtain
cash less frequently), sometimes provides an easier means of transacting a
purchase than a personal check, and generates receipts that may facilitate
merchandise returns or expense reimbursement.

The use of a credit card also

provides short-term "bridge" credit between paychecks or in advance of other
receipts of funds.
Bridge credit in small amounts is essentially a convenience that
helps a card user to adapt to nonsynchronous flows of income and expenditures.
To the "installment user," the credit card offers an attractive means to
obtain credit on a more extended basis.

Payment for purchases may be stretched

over several billing periods in accordance with account agreements which
commonly require minimum periodic payments of 5 to 10 percent of the total
amount owed.

In this respect, credit cards are more an alternative to fixed-

amount installment sales contracts or personal loans than to drawing down
cash or checking account balances.

-21The advantages of borrowing by credit cards are several.

For

instance, card users may borrow in the exact amount they wish to spend (within
their credit limit).

In contrast, personal loans generally are available only

for some minimum amount.

Installment sales contracts are likewise usually

limited by creditors to some minimum feasible size, such as for a major
appliance or set of furniture.

Also, credit card users make only one credit

application, at the time they request a card, and thereafter can borrow with
ease (as long as they meet a minimum payment schedule); installment sales
contracts and personal loans, on the other hand, usually require a separate
time-consuming process of application and approval for each extension of
credit.
Of further benefit to installment users of credit cards is the
payment flexibility of most credit card accounts.

Card holders may routinely

repay any portion of the balance owed, from the minimum amount required up
to the entire balance, at any time.

Other forms of installment credit

generally specify a fixed monthly payment established at the signing of the
contract.

On such loans, a smaller than scheduled payment may place the

loan in delinquent status and trigger penalty fees.

Partial or full pre

payments may result in rebates of prepaid interest on a basis not particularly
advantageous to the borrower.

Even for installment users, then, "convenience"

is an important attribute of credit cards— convenience in borrowing, primarily,
rather than convenience in transacting.
Not every card holder fits neatly into one usage category or the
other.

Convenience users who ordinarily pay credit card bills in full may

sometimes repay by installments— for example, after making an especially
large purchase.

Installment users, in turn, may at times pay off credit card

debts in full— for example, after receiving a large tax refund.

Nevertheless,

-22card holders generally can be classified into one category or the other
according to their customary payment habits.

From responses to questions

concerning repayment practices on credit card accounts contained in the Board's
1977 Consumer Credit Survey, it appeared that about half of U.S. card holders
were convenience users and the other half installment users.
3.2. Impact of Credit Cards on Expenditures
Isolating the impact of credit cards on consumer spending is diffi
cult.

Credit cards are so widely held, and the volume of business transacted

through cards is so large, that it seems only reasonable to suppose that
credit cards affect the way people spend.

Using a credit card to make some

unplanned purchase, or a purchase larger than intended, is perhaps a widely
shared experience.

Yet the precise nature and magnitude of the credit card's

impact on spending remain elusive.

Do credit cards in fact cause overall

spending to be larger than would otherwise be the case?
affect the timing of purchases?

Or do they primarily

Or perhaps the composition, rather than the

total amount, of consumer spending?
The relevance of these issues to the discount-for-cash debate
stems most directly from the possible offset to credit card costs at card
honoring retailers that may arise from any increase in sales volume associated
with acceptance of credit cards.

Any effect of credit cards on individual

spending behavior would seem to carry some implications for aggregate spending
as well.

Examining the relationship between credit cards and aggregate con

sumption, therefore, can help in assessing whether the relationship of credit
card use and sales volume at retail stores is significant.

If use of credit

cards stimulates aggregate spending, retailers as a group should derive
increased sales; but if card use has no appreciable impact on total spending,
then retailers as a group would realize no net sales gain to offset the

-23industry-wide costs of honoring credit cards.

Of course, merchants who

honor credit cards might gain sales from those who do not accept them, but
that situation becomes less likely as credit cards reach a mature stage of
development and retailer acceptance of credit cards becomes widespread.
The macroeconomic impact of credit cards is an important issue in
its own right.

Any factor that may influence spending habits of consumers

is relevant to public policy concerns focused on the general level of prices
and the scale of economic activity.

However, these issues— to be discussed

briefly in Chapter 5— appear secondary to the fundamental concern with consumer
equity embodied in the Cash Discount Act, which is to identify and to minimize
any possible subsidy of credit card users by cash users.
Microeconomic evidence.

One way to gain insights into how credit

cards affect consumer spending is to question a representative sampling of
persons about their spending and card use habits.

Some information of this

type was surveyed in Chapter 2, and more recent survey results concerning
unplanned purchases are discussed below.
Credit cards are sometimes believed to induce people to spend more
than they otherwise would by weakening the discipline on spending imposed by
in-pocket cash or checking account balances.

.Accordingly, many retailers feel

that they can boost their sales by accepting credit cards, and critics some
times assail the card for promoting ill-considered outlays that could lead
to financial problems for some households.
As suggested above, however, the common view that credit cards
influence spending does not necesarily imply greater spending in total, for
either a given household or in the aggregate.
or the composition of spending is affected.

It may be that only the timing
The convenience user, for example,

may buy on one day what he would otherwise wait a week or so to buy, with no

-24difference in his total spending during the period.

The installment user, of

course, would likely alter the timing of his purchases more substantially,
since without a credit card he might have to save for a purchase for a con
siderably longer time than would a convenience user.
For any credit card purchase, a compositional effect may be linked
with the timing effect.

Insofar as the credit card purchase must ultimately

be paid for by transferring funds, the card user may at some point cut back
on other expenditures, with no direct long-term impact on his overall spending.
An article of clothing purchased by credit card— perhaps on impulse— might
be "paid for" later by forgoing an alternative clothing purchase, or by
sacrificing some unrelated expenditure, such as an expensive dinner.
To obtain some notion of the possible link between credit cards,
unplanned or impulsive purchases, and changes in a household's total spending,
the Federal Reserve commissioned the Survey Research Center to include several
special questions on this subject in its January 1983 monthly survey of house
holds.

The answers to these questions did not indicate an especially strong

connection between credit card usage and household spending, a result con
sistent with the finding from other surveys that about one half of card
holding households typically use cards for convenience rather than to augment
purchasing power on a longer-term basis through installment use.
In the January 1983 survey, respondents were first asked if in the
past three months they had made any purchase larger than $20 that they "had
not planned to shop for when [they] went into the store." Respondents were
then asked, for each instance mentioned, what they had purchased, the price
of the item, why they had made the purchase, and whether they had done so
with cash, check, or credit card.

Those who had used a credit card were

-25then asked if they would have purchased the item had they not had a credit
card, and, if not, whether they would have purchased the item within the
next few months.
Forty-one percent of the survey respondents indicated that they had
made at least one unplanned purchase of $20 or larger in the preceding three
months.
purchase.

About 40 percent of those respondents reported more than one unplanned
The most common unplanned purchase fell in the broad category of

clothing, jewelry, and personal items, followed by household items including
major durables.
largest category.

Hobby, recreational, and educational items comprised the next
The purchased items covered a broad price range.

Twenty-

five and thirty dollars were the most frequently mentioned amounts (for the
first purchase discussed), but 35 percent mentioned purchase amounts of $100
or more, and almost 7 percent reported purchases of $500 or more.
For each unplanned purchase, respondents were asked "what was the
main reason that you decided to purchase the item at that time?"^

Not

surprisingly, nearly half the respondents answered that they "needed/wanted/
liked" the item purchased.

After all, any purchase presumably is made in

order to meet some perceived need or desire, even if the perception of that
need develops only a few moments in advance of the purchase.

Some of the

other responses were also need-related— for example, some said the item was
purchased to replace an older item that was "worn out" or "needed replacing
anyway."

The primary reason for purchase not directly related to need was

attractive pricing of the item, variously described as being "on sale," a
"bargain," or a "good deal."
reason.

Thirty percent of the respondents cited this

Thirteen percent said they bought the item as a gift or "to surprise1

1. Reasons given for purchase were unprompted; i.e., respondents answered in
any manner they chose, and not, for instance, by selecting their answer from
a list of possible reasons.

-26someone."

Reasons mentioned by less than 2 percent of the respondents were

that they "had extra money" or that the item "was hard to find" elsewhere or
at other times.

TABLE 3.1
UNPLANNED PURCHASE ACTIVITY
1
|
|

Number of
Responses

1
|
I

As Percent of:
Category
Total
Responses Responses

Total Responses
No unplanned purchase
Made unplanned purchase

644
380
264

100.0
59.0
41.0

How Paid for Unplanned Purchase
"Other"
Cash
Check
Credit card

2591
8
135
46
70

100.0
3.1
52.1
17.8
27.0

1.2
21.0
7.1
10.9

Behavior If Had No Credit Card
Buy at same time
No purchase at time

70
40
30

100.0
57.1
42.9

6.2
4.7

Subsequent Behavior
Purchase within few months
No purchase at all

30
19
11

100.0
63.3
36.7

3.0
1.7

1. Five respondents making unplanned purchases did not provide information
about method of transaction.
Responses to household survey, 1983.

A particularly interesting result of the survey is that only slightly
more than one-fourth of those making an unplanned purchase used a credit card
to do so (see table 3.1).

Unfortunately, no "control group" data exist on the

proportion of planned purchases made by credit card in the relevant categories
(clothing and personal, household goods, hobby and recreational).

Still, a fre

quency of one card purchase in four would not seem to establish a particularly

-27strong relationship between unplanned purchases and credit card use.1
A full 70 percent of the unplanned purchases were made either by cash
(52 percent) or by check (18 percent).
unidentified, means.

About 3 percent were made by other,

When purchases were classified by size, the incidence

of card use appeared to increase as purchases became larger, but not to a
striking extent.

For unplanned purchases above $100, 31 percent were trans

acted by credit card compared with 25 percent for transactions of $100 or less.
In all (considering only the first item mentioned), 70 respondents
made an unplanned purchase by credit card.

Forty of these purchasers

(57 percent) said they would have made the purchase at the time even if they
had not carried a credit card— they were not asked how— and 30 respondents
(43 percent) said they would not have made the purchase at that time without
their credit card.

Finally, the 30 respondents who would not have made the

purchase were asked if they would have made it within the next few months—
19 said yes, they would have, and 11 said no.
Responses to hypothetical questions, of course, have considerable
limitations.

Statements as to what one would do if circumstances were dif

ferent entail varying degrees of reliability for different respondents.
Still, in the absence of a compelling reason to suspect a large bias in the
answers provided, the survey results suggest that in only a small number of
cases might credit cards ultimately prove decisive in the completion of an
unplanned purchase.

Seventy-three percent of the unplanned purchases studied

were transacted by means other than credit card; another 15 percent would
1. In the Board's 1983 survey of retailers, among stores accepting credit cards,
about 22 percent of total sales at clothing stores were transacted by card, and
about 16 percent of furniture and appliance store sales were by card. This
survey is discussed in Chapters 4 and 6.

-28have been made at the same time even without access to a card; another
7 percent would have been carried out at some later time.

Only 4 percent of

all the completed purchases (11 of 259), or 16 percent of credit card pur
chases (11 of 70), would never have been made without a credit card, in the
judgment of the purchasers themselves.
Unplanned purchases, of course, represent only a fraction of total
purchases.

If the above proportions are reasonably accurate, it seems likely

that far less than 4 percent of all purchases— planned and unplanned— could
be described as sales that would never have taken place at all without credit
cards.

Moreover, even for those unanticipated purchases identified as entirely

dependent on credit cards, it is still not possible to say that they represent
a net addition to total spending.

In the absence of the card-dependent pur

chases and subsequent payment for them, it may be that different purchases
would have been made at some point, so that the total spending and total
saving of the individuals would have been the same over time in either case.
Macroeconomic evidence.

If individuals alter their spending behavior

as a result of holding credit cards, summation of individual outlays should
result in a corresponding alteration of aggregate consumption spending.

such a link could be detected, it would tend to substantiate the argument that
incremental sales from credit cards offset the purportedly higher cost of
credit card transactions (thereby making it less certain that credit card
costs are imbedded in retail prices).
As discussed in the preceding subsection, credit cards could generate
changes in the timing, the composition, or the amount of spending.

Credit

cards could cause incidental variations in the timing of purchases within a
short period (e.g., between paydays) and have few significant macroeconomic

-29effects. 1

Or, through household exercise of the borrowing function, they

could assist a more fundamental longer-term shift in the timing and/or the
composition of purchases.
The most direct way in which credit cards might influence the
total of consumption spending would be by increasing consumer propensities
to spend (reducing consumer propensities to save).

If consumers are con

sidered to have some desired rate of saving in a cardless environment, then
total spending could be enlarged by the existence of cards only if actual
saving by consumers fell below the initial desired level.

This outcome

might seem to hinge upon a widespread lack of consumer self-discipline in
saving, resulting in a condition of chronic overindebtedness.

An alternative

explanation, advanced by T. Russell and also tested by E. Montgomery, is
that prior imperfections in credit markets may have created a situation in
which consumer borrowing and total consumption were constrained to lower
than desired levels.^

To the extent that credit cards served to mitigate

these imperfections, they would tend to reduce the saving rate and boost
consumption.1
2
1. Changes in the timing of purchases due to card use could theoretically
affect the cyclicality of aggregate consumption spending, and therefore
economic activity in general.
Since credit cards (like all consumer credit
instruments) make possible a greater dichotomy between current spending and
current income, they could tend to be cyclically destablizing by boosting
spending even further during a boom period, or by retarding spending at other
times as repayment obligations impose a competing claim to spending as an end
use of current income. On the other hand, credit cards could just as well
serve a stabilizing function, for instance, by enabling households to maintain
a desired long-run spending path during periods of temporary unexpected short
falls in income. There is little documentation to suggest that these possible
cyclical effects are very important in actuality.
It is also possible that
individual cycles of credit card use and repayment are differently phased and
largely cancel out, resulting in little overall impact on economic aggregates.
2. Thomas Russell, The Economics of Bank Credit Cards (New York, Praeger,
1975).
Edward B. Montgomery, "Tests of Alternative Explanations of the Decline in the
Personal Saving Rate" (Ph.D. dissertation, Harvard University, 1982).

-30If credit cards stimulate total spending— whether by relaxing
capital market constraints on consumption or by undermining the consumer's
will power to save— the impact should be evident in a declining aggregate
saving rate as credit cards become more prevalent.

During the 1970s, third-

party credit cards were gaining broad distribution and use and, by and large,
the saving rate did drop somewhat from earlier levels.

By itself, however,

without regard to the myriad other factors that influence spending, this
fact is of little analytical value.
Russell's discussion of the link between credit cards and the
saving rate was largely theoretical, in the context of a model in which
the consumer arrives at an optimal allocation of lifetime income over time.
Credit cards are introduced into the model as one method of diminishing
restraints on the ability of younger consumers to borrow in anticipation of
future income.

For the U.S. economy, however, with its already well-developed

consumer credit markets providing other means of obtaining credit, it becomes
a difficult empirical question as to what extent credit cards might introduce
any further appreciable relaxation of capital market constraints.

Also, it

should be noted, the Russell model would result only in a redistribution of
consumption spending over time, unless total desired lifetime consumption
is altered by the existence of credit cards.
In one of the few explicit macroeconomic studies of this issue,
Montgomery calculated a maximum possible reduction in the saving rate of
0.3 percentage points during 1978 that might be associated with credit cards.^
He also concluded from cross-sectional data that credit cards appeared to
exert more of a downward impact on the saving rate in 1977 than in 1970
1. Montgomery, "Alternative Explanations," p. 26.

-31but that the magnitude of the impact was probably very small.^

G. Garcia,

summarizing her investigation of the literature in this area, concluded in
1980 that "the issue of the effects of credit cards on consumption remains a
subject for further research...The relationship of credit to the expansion
of and inflation in the economy remains to be adequately explained both at
the theoretical and empirical level."2
On the whole, the household survey on unplanned purchases discussed
above as well as existing macroeconomic research provide little grounds for
believing that credit cards generate incremental sales in sufficient volume
to offset credit card costs to any measurable degree.1
2
1. Ibid., p. 166.
2. Gillian Garcia, "Credit Cards: An Interdisciplinary Survey," Journal of
Consumer Research, vol. 6 (March 1980), p. 333.

-324.

EFFECT OF CREDIT CARD TRANSACTIONS ON COSTS OF RETAILERS
In Section 202 of the Cash Discount Act, the Congress designated

"the effect of charge card usage on merchants, including the effects on
merchant costs," as a major topic to be examined in the Federal Reserve
study.

This part of the report primarily addresses the question of the

costs incurred by retailers from credit card transactions, following some
further discussion of the impact of credit cards on merchant revenues.
4.1.

The Incentive to Engage in Credit Card Transactions
An individual merchant has two obvious possible motivations to sell

goods and services on credit.

One is to increase sales:

without credit, a

particular sale might not be completed at all; in addition, the provision of
credit through the merchant's own credit plan might establish a bond with the
customer, leading to additional future transactions.

A second reason for a

merchant to sell on his own credit plan might be to enhance revenues by earning
finance charges on receivables.

Most empirical studies, however, have concluded

that the direct variable and overhead expenses of operating a credit program
(including the cost of funds) have not been fully covered by finance charge
revenues.

In practice, the sales generation motive appears to have been the

dominant consideration underlying selling on credit.
The provision of open-book credit to known and trusted customers is
a practice perhaps as old as retail trade itself.

The broadening and formal

izing of charge account credit was pioneered by the large full-line department
stores in the 1940s and 1950s with the issuing of credit cards to customers
for use in the issuing store and its branches.

Initially, convenience was

the primary attraction to consumers of the store credit card account, since
most stores required full payment within the billing period of 30 to sometimes
90 days.

In time, major retailers adopted the practice of providing qualified

-33customers an extended payment option (with finance charges accruing on unpaid
balances).

As a result, open-ended "revolving credit" began to substitute for

longer-term closed-end credit as well as for cash transactions.

Third-party

card issuers subsequently entered the field by offering cards that could be
used at any business that contracted with the issuer for this purpose.
For both in-house and third-party credit card plans, generation of
incremental sales above the cash-only volume was the dominant consideration
underlying their adoption.

In many instances, the strategy may have been

defensive— to avoid losing sales to card-honoring competitors— but was never
theless attuned to achieving higher sales than deemed otherwise possible.

was generally believed that a card-holding customer, unfettered by the limita
tion of pocket cash or current checking account balance, would spend larger
amounts than otherwise likely.
To businesses issuing their own card, the building of customer
loyalty was an important sales-stimulating aspect of credit cards.

People

in possession of a store's credit card might habitually gravitate to that
store to shop, and the monthly billing statement served as a convenient
vehicle for presenting information about new products and services, special
sales, or anything else designed to spur additional purchases.
To smaller businesses, the honoring of credit cards issued by banks
or other third parties expanded their sales potential without the necessity
for merchants to manage their own credit card plans.

Expenses of application

review, billing, and collection would be handled for a fee by the third-party
issuer operating with the advantage of cost-minimizing economies of scale.
Today, any clothing boutique or similar occupant of the modern shopping mall
would likely suffer a decided competitive disadvantage if it did not accept
credit cards.

Even so, it is questionable whether the existence of credit

-34cards generates any incremental revenues for the retailing industry as a
whole.
As discussed in Chapter 3, little support has been found for the
view that card-holding consumers over the longer run spend more (save less)
of their income than they would without credit cards.

But if they do not,

then it would seem that card-honoring merchants can benefit only at the
expense of nonhonoring merchants.

On the other hand, if most merchants

honor credit cards, as may be true today, then none enjoys an advantage over
any other by doing so, and competition must focus upon other factors such as
product differences, pricing, and merchandise return policies.

In this

situation, any selling costs incurred from honoring cards, above the cost of
selling for cash, could be regarded as a net additional cost, in view of the
absence of any offsetting incremental sales revenue for the industry as a
whole.2
A good analogy to the impact of credit cards on retailers might be
found in the grocery store industry's issuance of trading stamps several
years ago.

The first stores to offer stamps apparently were able to attract

customers from competing stores, and to more than cover the costs of stamps
through incremental sales volume.

However, when others followed suit in self-

defense, it became questionable whether any store— or the industry as a whole—
benefitted from giving out stamps, since it is unlikely that people began to
eat more in order to obtain stamps.

In time, grocery stores grew dissatisfied1
2

1. Given the present stage of widespread credit card possession, it is not
even clear that card-honoring merchants as a group take net sales away from
non-honoring merchants as a group.
If non-honoring merchants are able to
appeal to price-sensitive cash buyers by offering lower prices, then they may
gain as much in sales to such customers as they lose from credit users forced
to shop elsewhere.
2. The timing effects associated with card use could redistribute sales among
retailers, but this result might be largely random, and likely to "even out"
for given retailers over a period of time.

-35with the expense of administering stamp giveaways, and many customers became
suspicious that the cost of the stamps might be imbedded in the prices they
were paying.

Customers who disliked the bother of collecting and redeeming

stamps might legitimately have complained that they were subsidizing the avid
stamp collectors by paying the same prices for their groceries.

In response

to all these negative aspects, some stores dropped their stamp programs and
began to advertise heavily a policy of lower prices.

Eventually, nearly all

grocery stores abandoned trading stamp issuance.
This analogy by no means implies that retailers will some day
abandon credit cards, or even that they would be wise to do so.

It may well

be that the consumer benefits of credit cards— the ability to alter the
timing of their purchases, to carry minimal amounts of cash, to borrow for
short periods, and so on— are of more substance than the perceived benefits
of receiving trading stamps from grocery stores, which was, in essence, an
inefficient means for consumers to obtain price discounts.

The primary point

of the analogy is to illustrate that the apparent gains to particular
retailers from offering some service can evaporate if competitors offer an
identical service, raising costs but leaving total industry-wide sales
unaffected.
If, in fact, the benefit of added sales volume from credit cards is
largely illusory on an industry-wide basis, the crucial consideration to the
subsidy issue becomes whether credit card transactions are more costly to
carry out than cash (or check) transactions.

If they are more costly, and

those costs are not covered by the finance charges and user fees paid by card
holders, then it would appear that cash buyers may indeed subsidize card users
by paying identical prices, or that retailers as a group may accept smaller
profit margins than otherwise available, or some combination of these outcomes.

-364.2.

Costs to Retailers of Credit Card Transactions
Comparative costs to retailers of accepting different means of

payment have been examined in a small number of earlier studies.

Also, in

connection with this report to Congress, the Federal Reserve Board conducted
a survey of retail businesses on the costs of accepting cash, check, and
credit cards.

The results of this survey are discussed below.1

At first glance, it might appear a foregone conclusion that credit
card transactions are more costly than other means of payment insofar as
merchants pay some percentage of their third-party credit card sales to the
card issuers, or incur various costs in operating their own credit card
plans that have no corollary in cash transactions.

Many retailers tend to

view the costs of handling cash transactions as equivalent to the cost of
doing business— a sales clerk, for instance, must be on hand to conduct
transactions of whatever type.

Thus there is a tendency to regard the mar

ginal cost of selling for cash as zero, but this view should not be adopted
without critical examination.
There are many elements of cost associated with the handling of a
sales transaction.

Some costs may be higher for check or credit card trans

actions, but others may be higher for cash.

Included among the relevant

cost concepts, for example, would be the time required to complete a trans
action, which may in turn influence the number of check-out stations and
sales clerks that a store needs.

Credit card transactions absorb time

because credit slips must be written and frequently some sort of authorization
procedure undertaken.

Personal checks usually trigger certain time-consuming

precautionary steps, such as inspecting and copying down identification data
1. Appendix B provides some information on the specifications of this survey
conducted in the spring of 1983.

-37or summoning a manager from elsewhere in the store to approve acceptance of
the check.

Cash transactions most likely consume less time than check or

credit card transactions, but the counting of cash received, the making of
change, and the stocking and replenishment of cash registers with currency
and coin are cash-related activities that occupy an employee's time.

Time

consumed in reconciling sales records with cash, checks, and credit slips on
hand may vary with the proportion of sales transacted by each means, and
from one business to another.
Security-related expenses comprise a large family of costs in which
further variation may be found among the different means of payment.

Included

in such a concept would be both direct expenses of security precautions plus
an allowance for any uncovered risk associated with each transaction medium.
An obvious risk, for example, is the possibility of theft.

This particular

risk is likely to be more pronounced for cash because the full negotiability
of cash makes it an attractive target.

Acceptance of personal checks entails

the risk that the check may be uncollectable, because the writer may not
have sufficient funds on deposit or for some other reason.

Security risks

borne by operators of in-house credit card plans include the costs associated
with delinquent and uncollectable accounts.
For a fee, of course, merchants can generally protect themselves
from many of these risks.

Employment of in-store security personnel, rental

of armored car service, use of more technologically sophisticated equipment,
payment of bonding and insurance fees, and subscription to a check guarantee
service all represent costs that retailers can incur to minimize losses from
theft, fraud, and other causes.

The costs arising from loss and protection

against loss may well differ among the types of payment and among different
businesses, and it is by no means obvious which means of transaction carries

-38the highest security-related costs, or how consistent the allocation of such
costs by transaction type would be from firm to firm.
Still other costs to retailers can be associated with the method of
transaction.

Every method other than cash involves some delay in receipt of

funds by the retailer, and therefore an implicit financing cost in forgone
interest on the funds eventually to be transferred.

And in-house credit card

plans involve a broad spectrum of bookkeeping and collection costs.

These

expenses, of course, may be offset at least partially by finance charge
revenues.
Perhaps the most visible transactions cost to retailers is a
factoring fee called the "merchant discount"— the fee paid by retailers to
third-party card issuers, figured as some percentage of the volume of credit
card sales.

This fee generally varies between 1 and 5 percent for different

merchants, depending chiefly on total credit card sales volume and per unit
transaction size.

It can be thought of as partly covering various operating

expenses that are shifted from the merchant to the card issuer, such as
billing and collecting costs that might otherwise arise if in-house card
plans were maintained, or the cost of loss and loss prevention associated
with cash and check.

However, since the card issuer obtains the revenues

from finance charges and related fees as well as absorbing the costs of
providing credit, the existence of the merchant discount may also reflect
some deficiency in the card issuer's coverage of credit costs solely through
financing income.
Empirical studies.

A number of studies have examined the costs of

credit card operations, or compared some aspects of credit costs with the
cost of cash and checks.

These include a study by Touche Ross & Co. of

costs and revenues from revolving credit at department stores in New York, a

-39study by Payments Systems, Inc. of comparative costs for cash, check and
credit transactions, and a study by R. Grant comparing the costs of these
modes of transactions in Great Britain.1
The Touche Ross study collected detailed cost and revenue data for
a 12-month period in 1972-73 from 17 retail firms in New York State operating
in-house revolving credit plans (generally linked to a store-issued credit
card).

The analysis covered all costs relating to new accounts processing,

account servicing, collection, space and equipment, payroll, and management.
Touche Ross also calculated the cost of capital associated with each store's
investment in receivables using two alternative methods— one based on each
firm's own capital structure and one based on an assumed capital cost rate
of 8 percent.
The principal finding of the study was that "retail stores in New
York do not collect sufficient finance charge revenues on their revolving
credit accounts to cover the costs of extending and servicing such accounts.
For the 17 stores surveyed, the deficiency totalled...3.71 percent of
credit sales.

Each of the 17 stores incurred deficits on their revolving

a c c o u n t s . S u m m a r y cost information from the Touche Ross study is presented
in-table 4.1.

As the table indicates, the cost of capital was the largest

component, accounting for about half of total credit costs (based on the
1. Payments Systems, Inc. Cost of Cash:

A Strategic Analysis (Atlanta, 1981)

Touche Ross & Co. "Economics of New York State Retail Store Revolving Credit
Operation for the Fiscal Year Ended January 31, 1973," in Robert P. Shay and
William C. Dunkelberg, Retail Store Credit Card Use in New York. Studies in
Consumer Credit, No. 4 (Graduate School of Business, Columbia University,
1975).
Robert M. Grant, "Transaction Costs to Retailers of Different Methods of
Payment. Result of a Pilot Study" (Report prepared at The City University,
London, 1982; processed).2
2. Shay and Dunkelberg, Retail Store Credit Card Use in New York, p. 9.

-40individualized estimate of capital cost).

Personnel costs and bad debt

losses were the next largest elements of cost.

TABLE 4.1
REVOLVING CREDIT REVENUE AND COSTS
AT 17 NEW YORK RETAIL STORES
AS A PERCENT OF REVOLVING CREDIT SALES

_______ All Stores (17)
Amount
Percent
$(000)
of Sales
NET REVOLVING CREDIT SALES (excluding
finance charge revenue)
FINANCE CHARGE REVENUE (net)
CREDIT COSTS:
Personnel costs:
New accounts
Account servicing
Account collection
Additional sales personnel
Supporting services
Management
Data processing
Total personnel costs
Data processing equipment
Credit investigation
Bad debt losses
Collection agency fees
Credit space and equipment
Postage
Communication
Supplies and other
Cost of capital
Total credit cards

$776,453.5

100.00%

59,033.9

7.60%

3,914.3
8,060.9
3,265.9
999.1
866.8

.50%
1.04
.42
.13
.11

376.7
1,941.2
19,424.9

.05
.25
2.50%

1,261.0
1,075.8
10,853.5
1,329.1
1,555.4
3,078.0
1,161.5
3,602.5
44,533.6
87,875.3

.16
.14
1.40
.17
.20
.40
.15
.46
5.73
11.31%

EXCESS/(DEFICIENCY) OF REVENUE OVER COSTS

$(28,814.4)

(3.71)%

EXCESS/(DEFICIENCY) OF REVENUE OVER COSTS
(at 8 percent cost of capital)

$(16,835.9)

(2.17)%

Source:

Touche Ross & Co., "Economics of Revolving Credit," from exhibit II,
p. 76.

-41The Touche Ross study reflected considerable effort to determine
relatively precise cost estimates from accounting records and from extensive
on-site discussions with store personnel.

Although much judgmental estima

tion was necessary to allocate certain types of costs between credit and
non-credit sales, the study did a credible job of establishing that the costs
to retailers of revolving credit operations exceeded financing revenues at the
stores examined.^

The study did not address the issue of incremental sales

revenue that might be attributable to credit cards, nor did it evaluate the
store-card as a marketing tool.

The relationship of the deficits incurred

on credit card operations to the overall profit margin on goods sold on
credit was also outside the scope of the study.
In 1980, Payments Systems, Inc. (PSl) made an extensive study of
the costs associated with cash transactions, measured on a per transaction
basis.

The study compared certain aspects of these costs, termed "handling

costs," with corresponding costs for checks and credit cards, and concluded
that "the per retail transaction cost of credit cards and cash is near the
same— about $.45— 'and checks only carry a small margin of higher costs."
PSI asserted that "the costs of handling cash are many times higher than
previously be 1ieved.. .(thus) retailers should take a new look at operating
efficiencies in payment acceptance and at the comparative acceptance
of new payment methods."2
1. In evaluating an earlier Touche Ross & Co. study using similar methodology,
the National Commission on Consumer Finance found the allocation procedures
used by Touche Ross to be reasonable, and accepted the Touche Ross finding
that in-house revolving credit plans operate at a deficit. While the Touche
Ross studies and National Commission commentary are at least 10 years old,
subsequent increases in the cost of capital in excess of finance charges
have likely preserved the validity of those earlier findings.
See National
Commission, Consumer Credit in the United States (Government Printing Office,*
2
1972) p. 145.
2. Payment Systems, Inc., Cost of Cash: A Strategic Analysis, p. viii.

-42The PSI study also calculated a "total system" cost of cash
transactions, which added security costs and theft losses to handling costs,
raising the estimated cost of cash to about 55 cents per transaction.

estimate was presented for a total system cost for checks or credit cards,
however.

Thus the major c o s t s of billing, collecting, bad debt expenses,

and use of capital (for in-house card plans) were omitted from cost compari
sons, as was the merchant discount fee for third-party cards, and losses on
uncollectable checks for that type of transaction.

The PSI estimates for

total system costs of cash are reproduced in table 4.2, and the comparative
handling costs for the three payment methods are provided in table 4.3.
On the whole, the PSI study likely succeeded in making its readers
more conscious of the non-trivial costs associated with cash and therefore
with the possibility of cost reduction through improved cash handling.

But

because the comparison with other means of transaction concentrated on
handling costs to the exclusion of other major elements of cost, the study
was not directly relevant to the issue of subsidization of credit buyers by
cash buyers.

Indirectly, by demonstrating a rough equivalence in point-of-

sale and other "handling" costs among the three payment methods, the PSI
study imparted credibility to the practical guideline of many retailers that
the marginal cost of cash is in effect zero and the marginal cost of (thirdparty) credit cards approximates the merchant discount.
Aside from limitations that stem from the incomplete coverage of
costs, several other limitations of the PSI study can be noted.

Among problems

pointed out by PSI are certain difficulties with some of the cost allocations,
such as for security costs.

PSI, in fact, considered the allocation problem

to be the study's major limitation.^1
1. Ibid., p. 199.

-43-

TABLE 4.2
TOTAL SYSTEM COSTS OF CASH
Per Retail Transaction
Mean
Median
Handling costs of retailers
Handling costs of banks
Armored car service
Retailer and Bank Security
Retailer and Bank Theft and Loss

Source:

$.41
.04
.02
.06
.02
$.55

Payments Systems, Inc., Cost of Cash :

$ .30
.04
.02
—
.01
$ .37

A Strategic Analy sis, p. 267.

TABLE 4 .3
HANDLING COSTS OF CASH BY MODE OF TRANSACTION
Per Transaction
(Means)
Cash
Point-of-sale transaction
Replenish registers
Reconcile registers
Reconcile in-store control
Reconcile out-store control
Prepare deposits
Transport deposits by internal employee
Total
Source:

Payments Systems, Inc., Cost of Cash :

Checks

Credit Cards

$ .24
.05
.08
.02
.02
.03
.01

.40
—
.05
.01
.01
.02
.01

.36
—
.03
.01
.01
.02
.01

$ .45

.50

.44

A Strategic Analyisis, p. 268.

Some questionable decisions were made in the PSI study that served
to narrow the gap between estimated cash costs and other costs.

Most notably,

PSI chose to use mean cost for the various functions examined rather than the
median cost, even though at one point it described median costs as "representing
the more stable and conservative data and analysis."1

Use of median costs

would have lowered the estimated handling cost of cash by about 10 cents,1
1. Ibid., p. 228.

44placing cash measurably below the other modes of transactions.

Also, though

cautioning the reader that not all stores experienced certain types of costs,
PSI included each functional cost calculation in the all-retailer estimates
of table 4.3 without any weighting to reflect its prevalence among retailers.
These costs were only minor components of the total, however.
In a study of retailer experience in the United Kingdom, R. Grant
concluded that the costs associated with credit cards exceeded the costs of
cash or check transactions, by approximately the amount of merchant discount
fees or in-house administration costs, but that per unit reductions in fixed
costs resulting from net additional sales more than offset the higher direct
costs of credit cards.

The economization on fixed costs through incremental

sales, however, was based entirely on assumption, rather than on empirical
evidence.
Grant's cost calculations are shown in table 4.4.

Categories

listed in the table roughly coincide with those examined by PSI.

Information

on average merchant discounts and any other charges imposed by suppliers of
payment services were obtained from the suppliers, cross-checked with inter
view information from retailers.

The other operating costs were estimated

on the basis of intensive interviews with five retail organizations and from
more limited contacts with a number of other retailers.

Grant noted consid

erable difficulty in identifying such costs accurately.

"None of these

costs," he stated, "were separately identified in retailers' accounting
systems in part because of the difficulties of allocating joint labor,
administrative and overhead costs, first to payment functions in general
and, second, between individual types of payments.1
1. Grant, "Transaction Costs to Retailers," p. 4.

-45TABLE 4.4
AVERAGE COSTS OF CASH, CHECKS, CREDIT CARDS, AND IN-HOUSE CREDIT
AS A PERCENTAGE OF THE RETAILER'S REVENUE FROM EACH TYPE OF PAYMENT, 1981

Check
%

«_

Cash

Discount charge
Salesperson's time
Additional cost of administraton
of cash and credit accounts
Cost of bank visit
Bank charges
Cost of credit
Losses from error, theft, fraud
Insurance

0.17
0.40
0.35
0.28
0.06
0.25
0.05

TOTAL OF POSITIVE COST ITEMS

1.56

Source:

1.56

T&E
Cards
%

In-house
credit
account
%
_

0.27

2.55
0.19

3.80
0.80

0.28

0.17
0.40
0.06
0.15
0.01

0.66
0.37
0.12
0.01
0.01

0.04
0.54
0.01
0.01

3.73
0.15
0.12
““

3.91

4.48

4.28

-5.57

-8.33

-8.25

-1.66

-3.85

-3.97

1.06

Reduction in unit overhead costs
arising from increased sales
generated by credit cards
and credit accounts

NET COST

Bank
Credit
Card
%

1.06

R. Grant, "Transaction Costs to Retailers," table 1, p. 5.

As shown in the table, Grant calculated that the cost of cash
averaged 1.56 percent of the total volume of cash sales, that the cost of
checks average 1.06 percent of check sales, and that the costs of credit card
plans ranged from about 4 to 4-1/2 percent of sales.

The major difference

between cash and checks was attributable to "additional administrative cost,"
which for cash represented primarily the cost of security precautions.

For

bank credit cards, the 2.55 percent discount charge represented the main
reason that credit card costs were higher than for other types of payment.
Subtracting that fee from total direct costs of bank cards indicates that

-46retailer operating costs for these cards lay midway between the cost of cash
and the cost of checks.
In discussing the possibility that acceptance of credit cards
boosts sales, Grant cited testimony of retailers before a government commis
sion that the principal effects of credit cards were "encouraging impulse
purchase, increasing the average value of purchases by consumers, and
facilitating purchases by overseas v i s i t o r s . T h e possible fallacy in this
view as applicable on an industry-wide basis has already been addressed.

any case, Grant calculated the reduction in fixed cost by assuming that, for
bank credit cards, 20 percent of revenues represented incremental sales; for
T&E and in-house cards, incremental sales were assumed to be 30 percent of
revenues.

Thus the seemingly important finding that credit cards lower per

unit costs when added sales are considered— and that T&E and in-house cards
lower per unit costs by more than bank cards— flows almost entirely from the
assumption that this is the case.
While Grant's study sheds no empirical light on whether or not
credit cards affect sales, it demonstrates that the cost-reduction benefit
of any sales boost would depend importantly on the ratio of fixed costs to
total revenues, and that this ratio varies widely across industries.

fixed costs are very low relative to sales, then any incremental sales gain
will result in only a very small reduction in per unit fixed costs.

Grant

identified "petrol dealers" (gasoline stations) as an extreme example of a
business with a low fixed cost-to-revenue ratio, which, coupled with a rela
tively low profit margin, implied that "even very large increases in petrol
sales (due to credit card acceptance) would fail to offset the higher costs
of credit transactions."21
2
1. Ibid, p. 12.
2. Ibid, p. 15.

-471983 survey of retailers.

In order to obtain an assessment of the

relative costs to retailers of cash, check, and credit card transactions
from a broad spectrum of businesses in the United States, the Federal Reserve
commissioned a survey of approximately 700 retail organizations.

The survey

was conducted by the Survey Research Center in April and May, 1983.
The survey focused on retail sellers of merchandise operating in
lines of business in which honoring credit cards was believed to be common
practice.

Grocery stores, for instance, were excluded from consideration,

whereas department stores and retailers of apparel, home furnishings, and
several other product lines were included.

In order to concentrate on

sellers of merchandise, most types of service providers were excluded, even
though credit card use may be common in some service trades.
hotels, for instance, were not studied.

Airlines and

To assure adequate coverage of

different sizes of business, the population was stratified into five size
groups for sample selection purposes.
Certain factual information was compiled about each respondent,
including type of business, dollar volume of sales, and the proportion of
business transacted by cash, check, and credit card.

For respondents

honoring third-party credit cards, the size of the factoring fee paid to the
card processor on credit card sales was recorded.
Unweighted averages of the proportions of sales volume transacted
by cash, check, credit card and "other" means reported by each respondent
are shown in table 4.5.

Retailers are grouped by the types of transactions

they engage in, and results are shown separately for gasoline stations and
all other respondents.

A further breakdown by size category is provided in

table 4.6 for acceptors of cash, checks, and third-party cards, for businesses
other than gas stations.

48A large majority of the businesses interviewed— nearly 80 percent—
honored third-party credit cards.

About one in six of these retailers also

transacted business through its own proprietary card.-*-

Most respondents—

almost 95 percent— also reported accepting checks to transact sales, although
many placed significant limitations on check acceptance.

About 15 percent

restricted acceptance of checks to those drawn on local banks, and nearly
10 percent took checks only from persons known to the retailer.
Reflecting these practices, about three quarters of the respondents
were categorized as engaging in cash, check, and third-party credit card
transactions.

Among such retailers outside the gasoline category, non-credit

sales were about equally apportioned between cash and check transactions.
The average proportion of sales on third-party credit cards was 12.5 percent
for non-gasoline merchants that also issue their own card, and 14.6 percent
for those without proprietary cards, as shown in table 4.5.

Proportions for

both the smallest and largest businesses (table 4.6) were 2 to 3 percentage
points below these overall averages.

Non-gasoline retailers that issue

their own credit cards typically transacted 37 percent of sales through the
store card.
Besides sales transacted through cash, personal check, or credit
card, retailers also transacted sales by travelers check, layaway plan,
checks drawn on businesses, and credit transactions in which credit cards
were not involved, all grouped in tables 4.5 and 4.6 under the heading "other
means."
1. Only a very few respondents that honored a proprietary card said that they
did not also honor third-party cards, and all but one of these respondents
were gasoline stations. However, some gas station operators apparently
treated a gasoline company credit card as a third-party card whereas others
treated it as proprietary, partly from failure of the question sequence to
specify a particular treatment. Thus the distinctions in table 4.5 between
third-party and store cards are not especially meaningful for gas stations.

-49table

4.5

DISTRIBUTION OF SALES BY MODE OF TRANSACTION

Types of
Transactions
Accepted____

Number

I
of
I
I Respondents I

Average Proportion of Business Transacted Byj,

Personal
Store
3rd-Party
Other
Cash______ Checks_____ Card________ Card______ Means

All Respondents
Cash
Cash,
Cash,
Cash,
Cash,

checks
credit cards^
checks, store cards
checks, 3rd-party
cards
Cash, checks, both cards

9
130
19
12

99.8
39.2
62.2
42.7

0
43.3
0
21.9

0
0
4.2
28.7

0
0
30.0
0

0.2
17.4
3.4
6.7

458
71

37.8
30.7

34.1
20.4

0
35.7

15.0
11.3

13.1
2.0

All Respondent s Except Gas Stations
Cash
Cash,
Cash,
Cash,
Cash,

checks
credit cards^
checks, store cards
checks, 3rd-party
cards
Cash, checks, both cards

5
123
11
1

96.0
37.9
60.6
22.0

0
43.9
0
22.0

0
0
3.6
56.0

0
0
31.6
0

4.0
18.1
4.1
0

422
46

36.2
25.6

35.5
23.0

0
37.0

14.5
12.5

13.7
1.9

Gasoline Service Stations
Cash
Cash,
Cash,
Cash,
Cash,

checks
credit cards^
checks, store cards
checks, 3d-party
cards
Cash, checks, both cards

4
7
8
11

100.0
62.6
64.6
44.5

0
32.6
0
21.9

0
0
5.0
26.3

0
0
27.9
0

0
4.9
2.5
7.3

36
25

56.1
40.1

17.4
15.6

0
32.9

20.4
9.2

6.1
2.2

1. Each respondent was asked to provide its proportion of sales by each transaction method.
Arithmetic averages of the responses appear in the table, with no attempt to weight responses
by size of the business. Figures provide a typical response rather than an estimate of the
true proportion of sales industry-wide made through each type of transaction.
2. Credit cards in this category may be store cards, third-party cards, or both.
Note: Rows may not add to 100.0 percent because of rounding and because of slight discrepancies
from 100.0 percent in answers provided by some respondents. Individual cases in which the sum
of the proportions deviated more than slightly from 100.0 percent were eliminated from the
calculations.
Responses from survey of retailers, 1983.

-50TABLE 4.6
DISTRIBUTION OF SALES BY MODE OF TRANSACTION
FOR ALL RESPONDENTS EXCEPT GASOLINE STATIONS
BY SIZE OF BUSINESS
Retailers Accepting Cash, Checks, and Third-Party Cards
Average Proportion of Business Transacted By:
Number of
3rd-Party
Store
Other
Respondents
Cash
Check
Card
Card
Means

Annual Volume
of Sales
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 99.9 million
$100 million and over

35
198
130
37
22

47 .6
36.9
28.8
37.4
54.6

40.3
35.4
36.0
35.2
27.9

11.0
14.6
15.6
15.2
11.4

1.1
13.1
19.6
12.3
6.1

Retailers Accepting Cash, Checks, and Both Credit Cards
Average Proportion of Business Transacted By:
Number of
Store
Other
3rd-Party
Respondents
Cash
Check
Card
Card
Means

Annual Volume
of Sales
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 99.9 million
$100 million and over

0
9
10
12
14

40.3
25.6
21.9
19.6

22.9
19.3
24.5
22.0

9.6
15.6
14.9
9.7

23.1
38.2
37.1
47.5

_
4.1
1.5
1.6
1.2

Responses from survey of retailers, 1983.

In questioning merchants about their transactions costs, a principal
objective was to direct the attention of respondents to all aspects of cost,
not merely to such explicit or easily ascertainable costs as the merchant
discount fee.

To achieve this objective, inquiries were made regarding three

separate categories of transaction costs, which were described to respondents
at the beginning of each series of questions. ' These categories were called
"point-of-sale and accounting costs," "loss and security costs," and "deposit
and financial costs."

Respondents were also asked to compare total transac

tion costs— combining these separate categories— among the types of transac
tions.

Certain explicit fees— the merchant discount fee and check guarantee

service costs— were excluded from the comparisons within each category of
cost, but included in the comparison of total transactions costs.

-51At the same time, it was recognized that many— probably most-retailers would not maintain detailed accounting information suitable for
quantitative cost comparisons among modes of transactions.

But it was also

anticipated that retailers nevertheless would be familiar with and could
evaluate aspects of their business that might have important implications for
their costs of operation.

Therefore, respondents were asked to make qualita

tive cost comparisons rather than dollar-and-cents estimates for the different
components of transactions cost.
Within each cost category, respondents were asked to make two-way
comparisons for each possible pair of transaction modes involving cash, check,
and third-party credit card (and store card, where applicable).

Respondents

were asked to designate whether costs in a particular category for one method
of transaction were more than, about the same as, or less than the cost of a
second method of transaction.

A summary of the cost comparisons by category

is presented in table 4.7, with a further breakdown of overall transactions
costs by size of business presented in table 4.8.
"Point-of-sale" costs were described to the retailers interviewed
as including "equipment and personnel costs for writing sales slips, making
change, obtaining verification and approval for checks and credit cards,
reconciling daily receipts, record keeping, and other point-of-sale costs
you may have."

In this category, a large number of merchants regarded cash

as the least costly mode of transaction compared with either checks or credit
cards. Nearly 80 percent said credit cards were more costly than cash.

Some

what more than one half of the respondents regarded credit cards as also more
costly than checks in the point-of-sale category (table 4.7).

-52TABLE 4.7
QUALITATIVE COMPARISON OF TRANSACTION COSTS FOR CASH,
CHECK, AND THIRD-PARTY CREDIT CARDS1
I____________ Frequency of Citation As:________
Cost Categories and
|_______ ______More Costly____________ | About
Transaction Pairings__________| Cash________ Check________ Card
| the Same
(Frequency of response in percent)
Point-of-sale costs
. cash
Check v s ,
Card vs. cash
Card vs. check

2
1
• • «

...

79
54

56
20
37

40
19

40
55
47

...

Security-related costs
Check vs. cash
Card vs. cash
Card vs. check

2
5

58
■• •
34

Deposit and financial costs^
Check vs. cash
Card vs. cash
Card vs. check

1
2

35
i« •
12

1
1
.. .

58
p* •
13

All costs combined-1
Check vs. cash
Card vs. cash
Card vs. check

...
43
25

...
88
61

64
55
63

41
11
26

1. For respondent engaging in all three modes of transaction.
2. Excludes merchant discount on credit cards and check guarantee fees .
3, Includes merchant discount and check guarantee fees .
Responses from survey of retailers, 1983.

"Loss and security" costs encompassed "loss or theft of cash, bad
or returned checks, credit card fraud, bonding and insurance fees, safekeeping
and other security costs."

The category thus included losses suffered by

retailers from theft or fraud as well as direct expenses to prevent or
provide compensation against such occurrences.

In this category, as in the

others, cash was regarded as the more expensive means of payment by only a
small proportion of retailers.

Loss and security costs, however, was the

one category in which credit cards were regarded by the retailers surveyed

-53as less costly than some other means of payment.

In comparing third-party

cards with checks, one-third of the retailers said checks were more costly
and only one-fifth cited cards as more costly.

About one-half said there

was little or no difference in security-related costs.
"Deposit and financial" costs were described as including "bank
service charges for deposits, costs to take deposits to a bank, and costs
associated with the delayed receipt of funds."

Check verification fees and

credit card factoring fees belong in this category, but were excluded from
the pair-wise comparisons so that attention could be focused on costs aside
from these explicit fees.

Within the category, more than half of the respon

dents saw little difference in cost for each of the paired comparisons.
Again, very few respondents thought cash was a more costly method.
After comparing transactions methods by category of costs, respon
dents were asked to consider all elements of cost, including fees for check
verification and credit card processing.
in the bottom tier of table 4.7.

The total cost comparison is shown

In comparing checks with cash, nearly 60 per

cent of the retailers thought checks were more costly, virtually all the rest
saw little difference in costs.

Credit cards were viewed by 88 percent of the

retailers as more costly than cash, when all aspects of cost were considered.!
Credit cards were regarded as more costly than checks by 61 percent of the
retailers.

However, 13 percent thought checks, in total, were more expensive

than credit cards.
Perceptions of relative transaction costs varied considerably among
different size categories of retailers, as shown in table 4.8, particularly in1
1. Tabulations not shown in the table indicate that only 2 percentage points
of that figure were due strictly to merchant discount fees; 86 percent of
the card-honoring retailers had ranked credit cards as more costly than cash
in at least one separate category of cost (and not lower than cash in any
other category).

-54TABLE 4.8
QUALITATIVE COMPARISONS OF TOTAL TRANSACTION COSTS
BETWEEN SELECTED MEANS OF PAYMENT
BY SIZE OF BUSINESS

Types of Transactions
and Annual Volume of Sales

1
1
1

Frequency of Citation As :
More Costly
| About
Cash
Check
Card
| the Same

Check vs. Cash
By size of business
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 99.9 million
$100 million and over

(Frequency of response in percent)
0
1
2
0
3

Card vs. Cash
By size of business
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 99.9 million
$100 million and over

0
1
1
0
0

Card vs. Check
By size of business
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 99.9 million
$100 million and over

47
50
56
81
87

• • •
• • •
«

• •
• •

16
10
12
23
28

53
49
42
19
10

84
87
87
88
100

16
12
12
12
0

70
63
61
46
48

14
27
27
32
24

Responses from survey of retailers, 1983.
the comparisons involving checks.

In comparing checks with cash, for instance,

smaller retailers were about evenly divided as to whether checks were more
costly or about the same cost as cash.

But in the two largest size groups,

80 percent or more of the retailers considered checks more costly.

Similarly,

a higher proportion of large retailers than of small retailers regarded checks
as more costly than credit cards, and the proportion citing credit cards as
more costly declined steadily as the sales volume category increased.
On the whole, then, retailers showed broad agreement in considering
credit cards to be a more costly mode of transaction than cash, and a majority

-55believed cards to be more costly than checks as well.

In general, checks were

regarded as more costly than cash, particularly by larger retailers, although
a large number of respondents saw little difference between them.

Within

categories of cost, retailers clearly felt that credit cards generated the
highest point-of-sale costs, while checks were more likely to result in
higher loss and security-related costs than the other methods.

Cost dif

ferences were seen least frequently for deposit and financial costs.1
Table 4.9 provides statistics on average merchant discount and check
verification fees paid.

As shown on the top line of the table, retailers

reported paying a 3.1 percent merchant discount fee, on average, and those
who subscribed to a check verification system paid an average of 3.0 percent
for that service.

The table also provides average fees paid among various

categories of retailers— by size, type of store, and proportion of sales by
credit card or check.
The merchant discount fee appears to vary with the size of a business,
measured by annual sales volume.

Businesses of less than $100 thousand in sales

reported an average factoring fee of 4.1 percent, while the largest businesses
($100 million and over) paid an average fee of 2.5 percent.

Among types of

businesses, those in the department store/general merchandise category paid an
average fee somewhat below the norm, which may in part reflect a high proportion1
1. Comparative costs are subject to change, of course, particularly as changes
occur in technology.
For instance, card issuers are currently addressing con
siderable attention to reducing credit card costs by curtailing the unauthorized
use of cards.
Electronic terminals at the point of sale that can access up-todate account information represent one avenue of possible reduction in credit
card costs. Efforts to enhance the security of card systems include development
of the "smart" credit card containing a small computer memory chip that can store
information such as the credit limit for the account, amounts already charged,
and a personal identification code that must be matched before the card can be
used. New credit card designs containing holographic images that would be
difficult and expensive to duplicate are being tested as a possible barrier to
counterfeit ing.

-56of large firms in that category.

Groups composed of furniture/appliance

stores, apparel stores, and gasoline stations each paid an average merchant
discount fee that was very close to the overall average, while a large group
of widely varied businesses paid a fee somewhat above average.

However, the

proportion of a business's sales transacted by credit card did not appear by
itself to be closely related to the size of the merchant discount fee.

TABLE 4.9
MERCHANT DISCOUNTS ON CREDIT CARDS AND CHECK VERIFICATION FEES

Categories of
Retailers

!
I
I

Merchant Discount
1 Average
Number of
1
fee
Respondents
1 (percent)

|
1
1

Check Verification
1 Average
Number of
1
fee
Respondents
1 (percent)

497

3.1

3.0

By Annual Sales
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 99.9 million
$100 million and over

35
225
153
51
33

4.1
3.3
3.1
2.6
2.5

0
8
18
12
3

2.8
3.2
2.9
2.5

By Type of Store
Department/Gen'1 Mdse.
Furniture/Appliance
Apparel
Gas Stations
All Other

37
102
68
62
228

2.6
2.9
3.2
3.2
3.4

5
5
8
3
20

2.8
2.6
2.6
4.2
3.1

Proportion of Sales by Card
5 percent or less
5.1 - 10 percent
10.1 - 15 percent
15.1 - 25 percent
More than 25 percent

168
119
44
75
80

3.4
3.0
2.8
3.0
3.1

..
..
..
..
..

All Respondents

Proportion of Sales by Check
10 percent or less
10.1 - 20 percent
20.1 - 35 percent
35.1 - 50 percent
More than 50 percent
Responses from survey of retailers, 1983.

...
• • •
• • .

11
10
11
6
0

...

3.0
2.8
2.6
3.5

-57Considerably fewer observations were available for check verifica
tion fees than for merchant discounts, which makes comparisons among size
groups and types of business rather tenuous for check fees.

It appears, for

instance, that the largest stores may pay smaller check verification fees,
but only three observations were available in that category.
In addition to the series of questions seeking qualitative cost
comparisons, retailers were also asked about the typical size of transaction,
and what they estimated the total transaction cost to be for each method of
payment accepted.

In essence, they were asked to make their best quantita

tive summary of the cost comparisons previously discussed.
expressed as a percentage of the amount of the transaction.

Responses were
For analytical

purposes, differences between cost estimates were computed for each pair of
transaction methods; mean and median differences and some distributional
data are presented in table 4.10.
On average, check transactions were estimated to be 1 percentage
point more costly than cash transactions, although as many as 10 percent of
the respondents thought the costs of checks exceeded the costs of cash by
more than 3 percentage points.

Compared with cash, third-party credit card

transactions averaged 2-1/4 percentage points higher in cost, and nearly 20
percent of the respondents indicated that the cost of cards exceeded cash by
more than 4 percentage points.

Compared with checks, credit cards were

about 1-1/2 percentage points more costly.
The quantitative estimates tend to substantiate the qualitative
comparisons insofar as cash ranks as the least costly method of transaction
and credit card as the most costly.

Yet the average differences in costs

appear rather small in light of other data collected in the survey.

-58noted, about four-fifths of the qualitative responses indicated that credit
cards were more costly than cash even before consideration of merchant discount
fees, which makes it likely that overall credit card costs would exceed cash
costs by at least somewhat more than the average size of the merchant discount.
However, the average estimated difference between credit card and cash costs,
at 2.19 percentage points, was nearly 1 percentage point less than the average
merchant discount.

While the quantitative cost estimates can hardly be regarded

as precise, they nevertheless suggest that retailers regard the differences in
in transaction costs among payment method as relatively small proportions of
transaction amounts.

TABLE 4.10
QUANTITATIVE ESTIMATES OF COST DIFFERENCES

Type of
Measure

1
1
1

Mean
Median

I
Cost Difference
i
Categories (in
|
percentage points)|
Less than 0
0
0.1 to 1.0
1.1 to 2.0
2.1 to 3.0
3.1 to 4.0
Over 4.0

Average Cost Difference in Percentage Points
Check
Credit Card
Credit Card
Compared
Compared
Compared
with Cash
with Cash
with Check
0.97
0

1.42

2.00

1.50

Percentage Distribution of Cost Differences
Credit Card
Check
Credit Card
Compared
Compared
Compared
with Check
with Cash
with Cash
6.4
44.6
21.1
11.3
6.4
3.4
6.9

Responses from survey of retailers, 1983.

2.19

9.5
14.4
12.9
16.4
18.4
9.0
19 .4

13.9
21.1
13.4
21.1
12.9
6.2
11.5

-595•

EFFECT OF CREDIT CARDS ON PRICES OF GOODS AND SERVICES
The Cash Discount Act specifies that the Federal Reserve study

should address "the effect of charge card usage on the pricing of goods and
services," and links this inquiry to a comparison of costs among methods of
payment.

This comparison was presented in Chapter 4.

If, as indicated there,

credit card costs are higher than for other types of payment, the primary
issue becomes:

do retailers incorporate the cost of credit into the prices

they charge, so that everyone pays a higher price than would be paid in the
absence of credit cards?
In addition to this essentially microeconomic question of price
determination, the possible effects of credit card usage on movements in the
general level of prices are sometimes discussed in legislative debate.

The

latter issue is really an aspect of a broader question about the macroeconomic
impact of credit cards, and is best viewed in a comprehensive framework that
considers jointly the impact of credit cards on the aggregate propensities
to consume and on the demand for money balances, under various assumptions
about resource utilization and policy actions.
5.1.

Retailer Pricing Behavior:

Microeconomic Perspective

A popular maxim is that "there's no such thing as a free lunch."
According to this dictum, retailers unquestionably recoup their creditrelated costs in the prices they charge for goods or services.

The costs

of doing business must be covered in the long run, since no firm can stay in
business indefinitely if it is unprofitable.

The coverage of credit card

costs is not simply a matter of retailers calculating that cost and arbitrarily
distributing it across the prices they charge, with no concern about any possiible repercussions uoon sales volume; rather, the cost of providing credit
is one of many elements that determine the retail supply curves for particular

-60products.

Prices in the marketplace are a result of both supply and demand

forces, reflecting all costs, including credit costs, that shape the supply
curve of retailers, and reflecting as well the incomes, tastes, and other
factors that determine the demand schedules of consumers.
In the short run, whether a credit cost increase is included in a
retailer's price becomes a question of that merchant's power to put the price
of a product or a service at whatever level he chooses.

The extent of this

power is determined largely by the degree to which raising prices to cover
the cost of credit will decrease the volume of sales.

If a retailer's poten

tial customers are not particularly sensitive to price changes, then any
increase in costs to a retailer— such as in the cost of carrying receivables
owing to rising interest rates— can be passed through more easily into the
retail price.

If buyers ar° resistant to price increases, then the retailer

in the short run may have to accept a smaller profit margin when costs rise.
Magnitude of price effect.

At the heart of the debate over the

objectives of the Cash Discount Act is the issue of whether consumers who
pay cash "subsidize" those who use credit cards, by virtue of the incorpora
tion of credit costs (not offset by finance revenues) into retail prices of
goods and services.

While it seems evident that any added cost associated

with credit cards would be incorporated in prices, the magnitude of the price
impact would be a key determinant of the practical significance of the subsidy.
From the discussion in Chapter 4, it appears that there may be some
costs linked to cash or check transactions that exceed corresponding costs
for credit card use, but other costs associated with cards that are negligible
in cash sales.

From interviews with retailers and from independent studies,

it would appear to be not far off the mark to view the purely transactional

-61of credit administration and financing of receivables as a rough approxima
tion of credit card costs.

These costs are partially offset by finance

charge revenues and user fees, with the net difference showing up at the
retail level as a credit department's operating deficit or as payment of the
merchant discount fee to a third-party card issuer.
The merchant discount fee and the credit department deficit have
been expressed in Chapter 4 as percentages of credit sales volume typically
ranging from 1 to 5 percent, and averaging about 3 percent.

From the survey

of retailers, however, credit sales appear to represent only about 15 percent
(third-party cards) to 30 percent (store cards) of total sales at stores
that typically accept credit cards, so that the uncovered portion of credit
card costs is spread over a total sales base considerably larger than the
credit sales volume itself.

Thus, total sales might be expected to incor

porate a premium for credit costs (uncovered bv credit revenues) ranging
from less than 1/2 percent to perhaps 1-1/4 percent, some part of which would
still be borne by credit card users in proportion to their 15 to 30 percent
share of total sales.

The implications for two-tier pricing that flow from

the magnitude of the price effects attributable to credit cards are discussed
in Chapter 6.
Price determination and credit surcharges.

The extent of short-run

pricing discretion of retailers is particularly relevant to one aspect of
the debate over discounts for cash and surcharges for credit associated with
the Cash Discount Act.

A central question concerned whether retailers, if

given the legislative license to add a surcharge for credit, would--or could—
set the credit price substantially above the cash price without first lowering
the cash price appreciably.

A small surcharge reflective of actual credit

•.osts would presumably conform with the intent of the Act; but a price hike

-62to credit card buyers far in excess of credit costs would thwart the Act's
objectives.

An expectation of the latter result would rest on either or

both of two implicit assumptions:

(1) that the retailer has the market

power to raise prices without significant loss of sales, or (2) that demand
for goods and services paid for by credit card is much less elastic than the
demand of cash buyers.
As discussed above, in a highly competitive situation, any attempt
by a seller to raise prices above a market-determined level would result in a
pronounced shift of sales to competitors.

Even in a less competitive situa

tion, the seller still faces a demand schedule on which higher prices are
associated with a smaller quantity demanded; if prices are raised, at least
some sales are lost.

Thus, to hike prices substantially and not suffer a

decline in total sales revenues, a retailer must face demand that is rela
tively inelastic, i.e., insensitive to price changes.

If this situation

exists, though, the question arises why goods would not already be priced at
a profit-maximizing level before enactment of any legislation to permit sur
charges for credit.

If demand at a given retailer can accommodate a large

surcharge, it could have supported a boost in the nominal price in any case—
unless the underlying demand schedules for card users and nonusers differ
radically.
Only if credit card users are insensitive to price changes whereas
cash buyers are responsive, would the conditions exist in which a price in
crease aimed at all customers might reduce sales revenue while a selective
price increase for card users increased revenue.

That is, even if markets are

not competitive, the market power of retailers is not necessarily enhanced by
the ability to charge different prices to credit card users, unless the demand
of such customers is significantly less elastic than that of cash customers.

-63However, there appears to be no convincing theoretical argument or empirical
evidence to suggest that such a dichotomous demand situation exists in fact.
Competition in retailing.

From the above discussion, it is clear

that the degree of competitiveness in retailing can be a key factor governing
the adjustment of prices to changing credit costs in a one-tier pricing
system, or the size of the premium that can be included in the credit price
in a two-tier system.

If markets are competitive, then changes in price by

any seller are constrained by the presence of many other sellers to whom
potential customers could turn.

The textbook case of pure competition

includes such primary characteristics as a large number of sellers (with
small shares of the market) and ease of entry for new firms, undifferentiated
products, and complete information available to buyers.

In practice, few

markets exhibit all of these characteristics, or any one of them in pure
form, except perhaps markets for some agricultural commodities.
Retailing would appear to be characterized by a large number of
sellers for any given product, though it is arguable that some sellers might
be of sufficient dominance in some localities to exercise considerable control
over price.

In most markets, though, the number of retail outlets strongly

suggests a reasonable approximation to the competitive model.
In addition to multiple sellers in retail markets, similarity of
merchandise is also observable, even though many forms of product variation
can be found that permit some degree of price differences.

Much effort, in

fact, goes into differentiating products by quality, styling, or special
features.

In many cases the ambiance, selling policies, or reputation of a

a store becomes an element of differentiation for any item offered for sale.
Nevertheless, for most products, the exact same brand will be available
in competing stores, closely comparable brands will be offered by other

-64competitors, and substitutes clearly distinct in some aspect will be available
in still other stores.
In such a retailing environment, it becomes difficult to envision
any merchant successfully tacking on a substantial surcharge above true
credit costs to his usual price without a significant loss of customers over
time.

A customer taken by surprise might pay such a surcharge once rather

than leave an intended purchase at the sales counter, but there would seem
to be little reason for that customer to patronize the store in the future.
Only stores where little repeat business is anticipated would appear
potentially able to gain from excessive surcharges.
The above observations on the competitiveness of retailing are
based for the most part on general impressions.

Unfortunately, few rigorous

studies exist that examine competition in markets that are relevant to this
report.

A rather extensive literature has developed regarding competition

in the sale of groceries, but since groceries are seldom purchased by credit
card, the findings of these studies are not directly useful for this report.
Neither are there published studies available that estimate the elasticity of
demand separately for credit card buyers as compared with cash buyers.
5.2.

Impact of Credit Card Use on Price Movements and Economic Activity
Some observers have argued that credit cards, by enabling their

holders to spend beyond the limits of their income, are a source of infla
tionary pressure in the economy.!

The concern that credit expansion may

exacerbate inflation is, of course, not confined to credit cards, although
interest has often focused upon these instruments.
1. The Credit Control Act of 1969, for instance, which expired in 1981, had
authorized the President to direct the Federal Reserve "to regulate and
control any or all extensions of credit....whenever the President determines
that such action is necessary or appropriate for the purpose of preventing
or controlling inflation generated by the extension of credit in an excessive
volume..." This law, as noted earlier, was invoked once during its statutory
existence, by President Carter in March 1980.

-65The demand-side effects of credit cards on price movements are
best understood as a special case of the broader relationship between credit
cards and economic activity.

In macroeconomic theory, two principal avenues

exist by which credit card use might affect overall economic activity and
the price level.

If the introduction of credit cards into an economy reduces

the desired saving rate, it would tend to increase output and aggregate
income through the stimulative effect of increased consumption (assuming
some initial slack in resource utilization that would permit expansion of
output).1
A second route by which credit cards could affect economic activity
is through their possible impact on the demand for money.

As a convenient

supplementary means of implementing purchases, credit cards might be expected
to reduce the transactions demand for money for any given level of income and
interest rates.

With credit cards available, consumers could carry less

currency and maintain smaller average checking account balances.

The avail

ability of a line of credit, moreover, might also reduce the precautionary
demand for money.

Thus, by enabling a given level of money supply to support

a larger nominal volume of transactions, which would show up in an increased
velocity of money, credit cards could contribute to expansion in real economic
output (given less than full employment initially).
Some qualifications to the foregoing analysis are necessary, how
ever.

One qualification concerns the assumption of an initial condition of

1. Further secondary effects would be governed by various elasticities
present in underlying relationships, and such factors as whether the money
supply remained fixed as the effects of credit cards emerged.
For instance,
with the rise in consumption, the transactions demand for money balances
would also tend to rise.
Assuming a fixed supply of money, interest rates
would have to rise in order to hold money demand constant. At higher interest
rates, some investment spending would be discouraged, limiting the initial
tendency towards economic expansion induced by credit cards. A full exploration
of the many possible outcomes that could arise from a card-induced increase in
consumption is beyond the scope of this report.

-66less than full employment.

If the economy is operating at a level approaching

full employment, then the output effects are by definition quite limited.
Any tendency of credit cards to boost the propensity to consume or to induce
the holding of smaller money balances would mainly result in a bidding up of
prices.
Second, the foregoing analysis describes what is essentially a shift
in equilibrium outcomes within an economy.

It describes a tendency to shift

to a higher output level or to a higher level of prices, given some change in
underlying circumstances, but the analysis does not help to interpret ongoing
economic processes such as the rates of change in output and prices over time.
That is, nothing in the foregoing analysis implies any significant long-run
impacts of credit cards on inflation or economic growth, except insofar as a
change in the equilibrium saving rate may alter the long-run capital
intensity of the economy.1
Third, the foregoing analysis assumed a given money supply, whereas
in actuality some adjustments in the money supply might be expected if a
measurable response by the economy to deployment of credit cards were
detected.

For credit cards to raise the general level of prices by reducing

the need for transactions balances, the further condition must pertain that
the monetary authorities would fail to recognize the shifting relationships
between the money stock and aggregate spending, and would aim for monetary
growth targets that were too high.

If this were the case, the resulting

inflation might be more properly seen as stemming as much from an error in
1. It is true, of course, that the utilization of credit cards has developed
gradually rather than as a one-time change in economic structure.
Thus, a
series of continual shifts in equilibrium over a number of years could appear
to be enhancing the process of economic growth or contributing to the process
of price inflation.
It would still need to be recognized that the inflationary
or growth effects would dissipate as the utilization of credit cards reached
a limit.

-67policy as from credit cards, per se, since the authorities could adjust
monetary targets to a more appropriate growth path.
The impact of credit cards on the saving rate has already been
discussed in Chapter 3.

Several studies in recent years have examined the

relationship between credit cards and the demand for money.

E. Marcus,1 in

1960, first examined the potential of credit cards to reduce the necessary
average level of money balances by enabling a better synchronization of
payments and receipts.

M. Flannery and D. Jaffee, and T. Russell, developed

models in which the transactions demand for money would be reduced as a result
of credit card use.2

K. White used cross-sectional data to conclude that

average balances held per dollar of credit card transactions are considerably
smaller than balances held for other types of transactions.^

G. Garcia and

S. Miller examined empirically the impact of credit cards on various com
ponents of alternative money concepts.^

Both found that the demand for Ml

is negatively related to a credit card variable, and that demand for time
deposits and for M2 was also negatively associated with credit cards.

general, however, while some economists claim to have detected a statistically
significant reduction of money demand associated with credit cards, the
magnitude of the impact has usually been small.
1. Edward Marcus, "The Impact of Credit Cards on Demand Deposit Utilization,"
Southern Economic Journal, vol. 26 (April 1960), pp. 314-16.
2. Mark J. Flannery and Dwight M. Jaffee, The Economic Implications of an
Electronic Monetary Transfer System (Lexington, Mass.: Lexington Books,*
4
3
1973).
3. Kenneth White, "Consumer Choice and Use of Bank Credit Cards: A Model
and Cross-Section Results," Journal of Consumer Research, vol. 2 (January
1975), pp. 10-18.
4. Gillian Garcia, "A Note of Bank Credit Cards Impact on Household Money
Holdings," Journal of Economics and Business, vol. 29 (Winter 1977),
pp. 152-54.; and "Bank Credit Cards, Time Deposits, and M2," Journal of
Economics and Business, vol. 30 (Spring/Summer 1978), pp, 230-35.
Stephen M. Miller, "The Money Supply Process and Credit Card Use: An Empirical
Analysis," Eastern Economic Journal, vol. 8 (April 1982), pp. 89-99.

-68In summary, it seems clear that some small impact on the level of
prices can be attributed to the positioning of retailer supply curves to
reflect credit card costs not borne by card users, but no demand-related or
other effects are discernible on the levels of output or of prices.

All told

there is little persuasive evidence that credit card use has caused any appre
ciable alteration in the demand for money, and the impact of credit cards on
the aggregate saving rate is also apparently quite small.

-69-

SEPARATE PRICING OF CREDIT CARD SERVICES AND RETAIL PRODUCTS
The Cash Discount Act of 1981 and its antecedents were designed to

remove legal impediments to the charging of separate prices for goods sold
for cash (or check) and for goods sold via credit cards.

The fundamental

objective of the Act was to foster a payments system in which the costs of
open-end credit were borne by those who use such credit, and not in any way
by those who do not use it.
Encouragement of a two-tier retail pricing structure was, of course,
one way to approach the desired allocation of credit costs; an alternative
way might have been to promote elimination of legal ceilings on consumer
interest rates and removal of any other barriers that prevent creditors from
charging the full cost of credit to its users.

In this section, two alterna

tive methods for achieving optimal allocation of credit card costs will be
examined:

(1) removing the barriers to recovery of credit costs through

finance charges and user fees, and (2) establishing a two-tier retail pricing
system through (a) discounts for the use of cash or (b) surcharges for the
use of credit.
6.1.

Cost Recovery Through Financing Revenues
Maximum interest rates that may be charged on consumer credit are

regulated by individual states, generally through complex sets of laws that
deal separately with different types of credit or different classes of
creditors.

Most laws governing consumer interest rates were enacted many

years ago to create exceptions to statutory or constitutional provisions
that had set a maximum "legal rate of interest," a rate generally recognized
as much too low to make feasible the extension of relatively small consumer
loans.

With some notable exceptions, the special rate ceilings established

-70for consumer lending originally were set sufficiently high to avoid signifi
cant restraint on the volume of credit.

Typically, 1-1/2 percent per month

(18 percent annually) has been the maximum interest rate on credit card
lending.

In several states, that rate has applied on balances up to certain

amounts, such as the first $500, with a lower rate applicable to amounts
owed above the threshold level.

A few states maintained maximums as low as

1 percent per month, and a few set ceilings as high as 1-3/4 percent.
Meanwhile, with the substantial rise in interest rates from the
mid- to late-1970s, the cost of carrying credit card receivables increased
considerably.

Given the inflexible statutory ceilings on credit card

interest rates, the rise in financing costs meant that earnings from such
lending deteriorated.

For bank issuers of credit cards, this declining

profitability is evident in figures from annual Federal Reserve System
surveys on costs associated with various banking functions, reported in the
Functional Cost Analysis.^-

Table 6.1 reproduces from this report selected*
2
1

data on credit card costs for recent years, with banks grouped into three
deposit-size classifications.

While the actual cost of funds may differ

from one institution to another, it is clear that on average the cost of
funds was the major factor in the shift from positive to negative profit
ability on bank credit card operations between 1977 and 1981.2
The shrinking profitability of credit cards in the late 1970s
provoked a number of responses among creditors and state legislatures.

With

rate increases impeded by state law and many card users escaping interest
charges by paying monthly bills in full, the imposition by creditors of
1. Federal Reserve Bank of Boston, Functional Cost Analysis (Federal Reserve
Bank of Boston, annual editions).
2. Comprehensive statistics for retail firms operating their own card plans are
not available for a similar time period, but retailers are subject to the same
general money and capital market forces as other suppliers of consumer credit.

-71"membership" fees unrelated to account activity was becoming increasingly
common in 1979.

It then spread rapidly in 1980 when federal credit controls

created an additional incentive to raise the price of consumer credit.^
Such user fees were illegal in certain states, but in some cases the legisla
tures revised their statutes to permit these non-interest assessments.

the late 1970s, lawmakers had also begun to raise or remove the restrictive
interest rate ceilings as well.^

In some cases, state legislatures were

prodded into action by the fact or likelihood of banks moving their credit
card operating arms to other states considered to have a more accommodating
environment for such business.
In all, between the end of 1978 and the close of 1981, 32 states
revised their laws governing interest rates on revolving credit accounts.
At the end of 1978, five states had ceilings below 1-1/2 percent for the
entire balance and 20 more states had ceilings below 1-1/2 percent applicable
to a part of the balance.

By the end of 1981, just one state constrained

rates to below 1-1/2 percent on any amount owed, and only nine states
maintained a limit below that level on some part of the balance.^
1. For certain types of credit, particularly "open-end" credit, creditors were
required under the controls program to post a special non-interest-bearing
deposit with the Federal Reserve for any increase in credit outstanding above
a specified "base" amount.
2. Ohio, for example, has revised its consumer lending statutes twice since
1979. Effective in March of 1980, it brought allowable interest rates on
revolving credit up to 1-1/2 percent per month from a previous graduated
ceiling capped at 1 percent on balances over $400.
Then in early 1982 it
authorized creditors to charge whatever rate were established by contract
with the borrower, not to exceed 25 percent per year.
Several other states,
including New Jersey and New York, now likewise limit finance charges to the
rate "set by contract." Washington and Minnesota, two states which formerly
capped credit card interest rates at 1 percent per month, have revised their
laws.
In Minnesota, customers now have the option of paying a 1 percent
monthly finance charge plus an annual fee (maximum of $15), or a finance
rate of 1-1/2 percent per month with no fee permitted.
In Washington, the
ceiling was raised to 1-1/2 percent per month in 1981, and Washington voters
subsequently rejected an initiative item that would have restored the
pre-1981 1 percent limit.
3. Charles H. Gushee, ed., The Cost of Personal Borrowing in the United
States (Boston:
Financial Publishing Company, 1979, 1982).

-72TABLE 6.1
NET EARNINGS ON CREDIT CARD PLANS AT COMMERCIAL BANKS
FOR SELECTED YEARS BY DEPOSIT SIZE CATEGORIES

Bank Categories by Deposit Size

1 Earnings and Costs as Percent of Receivables
|
1977
|
1979
1
1980
1
1981

Less than $50 million
Net earnings before cost of money
Cost of money
Net earnings after cost of money

4.63
4.97
-.33

3.89
5.80
-1.91

4.70
6.90
-2.20

4.96
8.49
-3.53

6.40
4.77
1.62

6.42
6.10
-.32

6.85
7.12
-0.27

7.98
9.05
-1.07

7.95
4.63
3.32

8.32
6.52
1.80

6.17
7.95
-1.78

10.86
9.53
1.33

$50 - $200 million
Net earnings before cost of money
Cost of money
Net earnings after cost of money
More than $200 million
Net earnings before cost of money
Cost of money
Net earnings after cost of money
Source:

Federal Reserve Bank of Boston, Functional Cost Analysis, 1978, 1980,
1981, 1982.

While rate ceilings have been perhaps the principal barrier to fully
recovering the cost of credit directly from credit users,1 other factors such
as the customary interest-free "grace period" on accounts paid in full may
also affect a creditor's ability to cover costs.

The costliness of any grace

1. In 1968, G. Lynch found that prices paid on selected appliances in Little
Rock, Arkansas (where finance rates were subject to a constitutional ceiling
of 10 percent) were from 3 to 7 percent higher than prices paid in cities
located in less restrictive states. The National Commission on Consumer
Finance concluded that:
"Regardless of the costs of providing any form of
sales credit, a reduction by legislative fiat of the permitted gross income
from finance charges necessitates adjustments in goods prices, fees, or
availability.
If not, lowered profits will force some retailers— probably
small ones— out of business. While credit sellers may recover part of their
lost income by reducing other services or adding fees for services previously
furnished without charge, the most likely offset is an increase in cash prices
resulting in a subsidy of credit by cash purchasers.
(See: Gene C. Lynch,
"Consumer Credit at Ten Per Cent Simple: The Arkansas Case," University of
Illinois Law Review (1968), pp. 592-601, and National Commission, Consumer
Credit in the United States, p. 107.)

-73period, of course, would vary with the cost of funds involved in financing
receivables.1
The assessment of user fees and a moderate boosting of finance
rates since around 1980 have been gradually shifting more of the cost of
credit card operations onto the users of credit cards.

Some card issuers

have also acted to circumscribe the grace period by charging interest from
the date of billing to the date of payment on accounts paid in full, or by
charging a monthly "maintenance fee" on such accounts.

These developments

may be reducing the need to cover credit costs through merchant discount fees^
or through higher prices charged for goods and services.

The survey of

retailers summarized in Chapter 4 suggests that merchant discounts indeed may
have been pared down on average in recent years.

The average fee reported

there of 3 percent (unweighted in any way for size of firm) and the proportion
of respondents paying a 5 percent fee are both lower than corresponding
1. At least one economist, however, has concluded that "the impact of the
so-called 'free ride' is probably substantially less than often suggested."
From an examination of account records at a large retail chain in 1973, E. R.
McAlister found that the 26 percent of active account holders who paid no
finance charge during a 12-month period represented a much smaller share
(4 percent) of total balances outstanding.
(See E. Ray McAlister, with
Edward DeSpain, An Empirical Analysis of Retail Revolving Credit (West
Lafayette, Ind.: Krannert Graduate School of Management, Purdue University,
1975), pp. 47-48.) But McAlister, in turn, may have understated the magnitude
of the "free ride." For one thing, the 49 percent who paid a finance charge
"some of the time" also obtained a "free ride" on occasion, perhaps frequently,
but McAlister did not report in detail on experience with these credit users.
The significant rise in the costs of financing receivables since 1973 would
also serve to temper McAlister's dismissal of the grace period's importance
in the overall credit cost structure.
2. A study of four states having widely different rate ceilings found that
the average merchant discount fee in a low-ceiling state (Arkansas) was con
siderably higher than in a high-ceiling state (Illinois).
See Robert W.
Johnson, Retailers:
CRC 1979 Creditor Survey (West Lafayette, Ind.:
Krannert Graduate School of Management, Purdue University, 1980). For a
similar finding comparing merchant discounts in California and Washington
State, see G. G. Gordon and others, The Impact of a Consumer Credit Interest
Limitation Law (Seattle: University of Washington, 1970), p. 19.

-74measures generally believed to prevail a few years ago.^

Legal barriers in

several states still limit recourse to some or all of the methods for covering
credit card costs discussed here, but certainly to a lesser extent than a few
years ago.

Continued state legislative action on this front could in time

relegate the approach of the Cash Discount Act to a secondary role.2
6.2.

Two-tier Pricing Structure
If the costs of credit are not fully met by financing revenues, they

could theoretically be recovered from users of credit by charging them an
appropriately higher price than paid by cash buyers.

That is, any particular

item could carry two prices, a cash price and a higher credit price.3
is the approach encouraged by the Cash Discount Act.

This

As noted earlier, the

Act also makes a further distinction between discounts for cash and surcharges
for credit.

A two-tier price structure established through discounts for

cash is favored by the Act; two-tier pricing arrived at through a surcharge
for credit is effectively barred.
The distinction between surcharges and discounts has little apparent
foundation in economic theory.

Economically speaking, the two are functional

equivalents; in a two-tier system tied to the cost of credit, there are simply
two separate prices, with the difference between them representing credit
1. Comparable survey data are not available for earlier periods, but personnel
at a major card interchange system confirm that merchant discount fees have
generally dropped in the past three to five years.
2. The effective removal of artifical barriers to finance rates and other
fees would result in the determination of direct charges to credit users and
factoring fees to retailers by market forces. The "merchant discount" would
not necessarily be eliminated entirely, but would be established in a more
fully competitive environment.
3. In fact, several price tiers would be allowable under the Act, apparently
as long as the credit price— the "regular" price— occupied the highest tier.
Given that the costs of checks for many retailers are less than for credit
cards and more than for cash, some merchants might wish to adopt a three-tier
pricing system.
Discounts for cash could also vary by the size of the trans
action or by the type of merchandise purchased.
Three-tier and other possible
pricing structures are not discussed in detail in this report.

-75costs not offset by financing revenues.

Whether that difference is called a

"surcharge" in reference to the lower price or a "discount" in reference to
the higher price should not matter.

Nevertheless, there may exist some

practical considerations that warrant a legal distinction between surcharges
and discounts.
From one viewpoint, it might appear obvious that surcharges and
discounts would result in different pairs of prices.

After all, if an item

regularly sells for $20, a $1 discount for cash establishes a $20/$19 price
structure, while a $1 surcharge for credit creates a. $21/$20 price structure.
The root problem with this view is the implicit assumption of a fixed, iden
tifiable, "regular price" from which all adjustments would be made.
of course, prices at the retail level may be altered repeatedly.

In fact,

Merchandise

already labeled with a single price of $20 (for example) could be first
repriced to $21, then offered on a discount-for-cash basis at some later
point.

Banning surcharges would not prevent establishment of a $21/$20

price structure, at least in the long run.

For seasonal merchandise, such as

clothing, the notion of an identifiable regular price is even more elusive—
old stock is periodically removed and new items are offered for sale with
freshly tagged prices.

For a newly stocked item with a price tag of, say,

$39 credit/$37 cash, no original one-tier regular price could be identified.
Perhaps the item would have been priced at $38 under a single-price system;
in fact, there is no way to tell.
Another way to view this issue is to ask why a merchant charging
all customers $20 for a certain item would willingly reduce the price to $19
for some segment of his customers.
$19?

If he could get $20, why would he charge

One possibility is that, by tying the discount to payment by cash, the

merchant might hope to stimulate a shift from credit card use to cash that

-76would reduce his credit costs, thereby "paying for" the selective price
reduction.

The success of such a policy would require that the initial

proportion of sales on credit cards be high and that a substantial switch
from credit to cash occur in response to the offered discount (or that the
cost of providing credit be very high).
For instance, if only 20 percent of sales are on credit prior to
the discount, then any merchant choosing to discount from his "old" regular
price would be reducing the price to the 80 percent of his clientele who
already use cash (and pay his regular price) as well as to the much smaller
target group of credit users who can be persuaded to switch to cash.

even half of those who normally use credit shift to cash (10 percent of the
total clientele in this example), the cost of credit would have to be
8 times larger than any discount from the regular price if net profits are
to be undisturbed.

Based on the likely relationship between the costs of

cash and the costs of credit discussed in earlier sections, the merchant in
this situation almost certainly would have to raise his regular price before
applying a discount in order to avoid a reduction in profits.^
But the offer of a discount might increase sales, it could also be
argued, which could provide an additional offset to credit costs.
possibility requires careful analysis, however.

This

The wholesale cost to the

retailer of additional merchandise would have to be covered, as well as the
reduced profit margins on items that could have been sold at the higher price,
and any other increase in selling costs associated with higher volume.

These

requirements suggest the necessity that the merchant face a highly elastic
1. A more detailed example of how prices in a two-tier system might compare
with the price in a single-price system is presented in Appendix C. The
hypothetical example, for a gasoline service station that switches to a
discount-for-cash system, utilizes some survey data on consumer reactions to
gasoline discounts discussed below in Chapter 6, section 3.

-77demand curve.

From the point of view of a single merchant who offers a

discount (while most competitors do not), the sales increase argument seems
to depend on competitors observing a loss of customers without retaliating
through their own pricing strategies.

If compensating actions of competitors

are assumed, so that a sales increase for a typical merchant would have to
represent "new" business not attracted from competitors— then the sales gain
argument requires that industry-wide demand for the product be highly elastic;
that is, that a reduction in price stimulates enough additional sales to
increase total revenues by more than the cost of additional merchandise.

But

if this demand configuration exists, it generates a motivation— completely
apart from the discount issue— to lower the price and reap additional sales.
It then becomes necessary to explain why retailers would operate at an inferior
pricing position prior to the time that discounts for cash became an option.
Perhaps the most straightforward argument for making a distinction
between a surcharge and a discount— an argument that was employed in Senate
floor discussions— is that to allow both approaches to two-tier pricing
could breed unnecessary and detrimental confusion among consumers.

If only

discounts are allowed from the posted price, potential purchasers would always
know that they would be charged no higher than the posted price; if surcharges
are allowed as well, customers would be less sure whether the posted price is
the higher credit price or the lower cash price.

If advertising or in-store

displays fail to make a surcharge policy clear, credit card customers may be
attracted by a low advertised cash price and wind up paying an unexpectedly
higher credit price.
The force of the above argument depends in part upon the degree of
competitiveness in the marketplace, as noted in Chapter 5.

In the long run,

if retailing is competitive, stores that mislead customers about surcharge

-78practices stand to lose customers to more forthright competitors.

Consumers

might be caught unaware by a surcharge in some instances, but would be unlikely
to be "stung" repeatedly.^

Experience would lead consumers to avoid future

visits to stores with poorly publicized surcharge policies, to come prepared
to pay cash, or at least to shop with the knowledge that the credit price at
certain stores is higher than the tagged price.

Similarly, competition would

tend to minimize the size of any surcharge, presumably to the approximate
cost of uncovered credit costs.
6.3.

Buyer and Seller Attitudes to Discounts
The first sections of this Chapter discussed the possible imple

mentation of discount-for-cash plans primarily from a theoretical standpoint.
Earlier sections addressed the cost conditions and card use habits that would
affect the feasibility of two-tier pricing.

But whatever the feasibility,

the questions remain whether retailers operating in the marketplace would
find two-tier pricing an attractive alternative, and to what extent consumers
would respond to discounts for cash by switching from credit cards to cash.
Recent surveys provide some indication of consumer reaction to
discounts for cash.

The Federal Reserve has sponsored two surveys, one con

cerning gasoline purchases and the other dealing with likely responses to
offers of discounts in various hypothetical situations.

A pair of independent

researchers has also obtained consumer responses to hypothetical discount
offers, which they have integrated into a mathematical model for determination
of an optimal size of discount.
Survey of gasoline purchases.

By early 1983, gasoline purchase

was the one area of retailing in which price discounts for cash payment were
1. Stores that do not depend upon repeat business, of course, would be better
positioned to maintain a policy of high but poorly communicated surcharges.

-79offered to consumers on a widespread basis.

The major gasoline refining

and marketing companies, rather than local dealers, have been the principal
proponents of two-tier pricing for gas.

Faced from the mid-1970s until

lately with steady increases in the cost of funds necessary to carry consumer
receivables, the gasoline companies have sought various means to dissuade
customers from using credit cards.

Some companies had experimented with

two-tier pricing in selected localities for several years, but it was not
until the summer of 1982 that discounts for cash were made widely available.
To document consumer reaction to these discounts, a survey of households
about their gasoline buying behavior was conducted for the Federal Reserve
by the Survey Research Center in January 1983.
In that survey, 52 percent of the almost 700 respondents possessed
either a bank credit card, a gasoline company credit card, or a general
purpose credit card (or combination of such cards).

Just over half of these

cardholders, however, reported that they "never" used credit cards to buy
gasoline.

By contrast, slightly more than 20 percent said they "always"

used a credit card to buy gas.

The remainder designated a frequency of

credit card purchase ranging from one-fourth to three-fourths of the time.
Respondents who held gasoline company cards— about 30 percent of the full
sample— were also asked whether they used gasoline cards on a weekly, a
monthly, or a lesser frequency.

Nearly one-half of that subgroup said they

used gasoline cards weekly, about 10 percent said they did not use the cards
at all.
Respondents who held a bank, gasoline, or general purpose credit
card were questioned further about their experience with discounts for cash.
Results of some of these questions are presented in table 6.2.

By January

1983, 60 percent of these respondents, at least once in the past year, had

-80been to a gasoline station that offered a discount for cash.

Those thereby

exposed to discounts were asked how they had paid for their purchase of gas
on the most recent occasion that a discount had been available.
quarters of those answering the question had paid by cash.

About three-

Since somewhat

more than 60 percent of card holders had reported generally using cash,l
it appears that the offer of a discount for cash generated a modest increase
in the proportion of customers paying cash.
Certain characteristics of those who pay cash and those who use
credit cards when offered discounts can be observed.

When respondents are

classified either as frequent credit card users or as frequent cash users, it
can be seen, as might be expected, that virtually all of those who paid by
credit card when offered a discount for cash were classified as frequent
users of credit cards.

Table 6.2 also shows that of 78 respondents classi

fied as frequent users of credit cards,2 59 percent had used their credit
card to buy gas the last time that a discount was offered, and 41 percent
had paid with cash.

Roughly speaking, then, about 40 percent of the target

population surveyed (those who often use credit cards) used cash when offered
a discount.

Some of these, of course, might have used cash anyway, reducing

the number of consumers that can be regarded as having altered their means of
payment in response to the discount for cash.
To further investigate responses to discounts, respondents who had
paid cash on the most recent offer of a discount were asked how they would
1. Those "generally using" cash included the approximate one-half of card
holders that "never" used a credit card to buy gasoline, and some others—
about 10 percent of the sample— who sometimes used a card but more frequently
used cash.
2. Eighty-five respondents were identified as frequent card users, but 7 did
not answer the question about their most recent purchase when a discount was
available.

-81-

TABLE 6.2
USE OF CREDIT CARDS OR CASH IN PAYMENT FOR GAS
AND EXPOSURE TO DISCOUNT FOR CASH

All
1[
Use Card1
Card Holders
Frequently
1 Number Percent ! Number Percent

Card holding respondents^
a. Not offered discount^
b. Were offered discounts^

Respondents offered discount^
a. Paid by credit card^
b. Paid by cash^

Respondents paying cash when
offered discount^
a. Would have used cash^
b. Would have used card^

Use Cashz

1 Frequently
1 Number Percent

354

100

129

100

220

100

143
211

40
60

44
85

34
66

94
126

43
57

199

100

121

100

49
150

25
75

46
32

59
41

3
118

2
98

147

100

115

100

124
23

84
16

20
12

63
37

104
11

90
10

1. Use a credit card for one-half or more of gasoline purchases, or for one-fourth of
purchases if gasoline card usage is weekly.
2. Use a credit card for one-fourth or less of purchases, and gasoline card usage is
less than weekly.
3. Holders of bank, gasoline company, or general purpose credit cards. Those who hold
only retail store credit cards are excluded.
4. Respondents were asked if on any occasion in the past year they had been offered a
discount to pay cash for gasoline. Respondents on line 2 are fewer than on line
l.b. because some respondents did not provide answers for 2.a. and 2.b.
5. Those exposed to a discount at least once in past year were asked how they paid
for gas on the most recent occasion that they were offered a discount. Respondents
on line 3 are fewer than on line 2.b. because some respondents did not provide
answers for 3.a. and 3.b.
6. Respondents who paid cash when offered a discount were asked how they
would have paid for the gasoline purchase in the absence of a discount offer.
Responses from household survey, 1983.

have paid for the gas in the absence of a discount.
they would have paid cash anyway.
they would have used a credit card.

Eighty-four percent said

Twenty-three respondents (16 percent) said
Looking only at the 32 frequent card

users who paid cash when offered a discount, 20 said they would have paid

-82cash in the absence of a discount, and only 12 said they would have used a
credit card.

Thus, based on responses to this hypothetical question, the

proportion of people who would actually alter their intended means of payment
when offered a discount may be considerably smaller than the 40 percent sug
gested by a simple breakdown of frequent card users into categories of
cash payment and credit payment.

Of 78 frequent card users in the survey,

32 used cash, but for only 12 of these did use of cash actually represent a
change in how they would have paid for the specific purchase in question.
Some of these results can be used to construct a hypothetical
example of gasoline pricing before and after adoption of a discount for cash
program.

The example illustrates the argument advanced earlier that when a

relatively large number of consumers use cash initially and/or when a rela
tively small number shift from card to cash when offered a discount, a seller
must raise the "regular" price before applying the discount if a given level
of profitability is to be maintained.

The details of this example are given

in Appendix C.
Survey of hypothetical reactions to discounts.

In another monthly

SRC survey, in October 1982, consumer reactions to discounts for cash on
purchases of furniture and appliances and clothing were probed through a
series of questions about certain hypothetical situations.

Respondents

identified as possessing at least one type of credit card among bank, store,
and "general purpose" cards were asked to what extent they used a credit
card to transact purchases in the durable goods and clothing categories.
Choices were: "never, one-fourth of the time, about half, three-fourths, or
all of the time."

Dollar amounts of purchase were not specified, but it

seems likely that furniture and appliance purchases would represent a fairly
large dollar amount, while clothing would cover a broader range.

-83Respondents who said that they used a credit card some or all of
the time (all responses other than "never” ) were then asked what they thought
their card use would be if a discount of 3 percent were offered for paying
by cash or check.

Respondents who still indicated they would use a credit

card at least some of the time were then asked about their reaction to a
5 percent discount; this procedure was repeated for discounts of 7 and 9 per
cent.

There are obvious reservations that attach to this line of questioning.

Aside from possible variance between hypothetical and actual reactions to a
situation, the progressive nature of the questions risked inviting a response
that credit cards would not be used if discounts were available.

Neverthe

less, it was believed that responses to such questions would provide a rough
approximation of consumer sensitivity to discounts for cash.
Results for durable goods purchases are shown in table 6.3.

The

top panel presents responses relative to the number of card holders in the
survey— around two-thirds of the panel.

Among card-holding respondents,

48 percent said they never used credit cards to purchase furniture or appli
ances; 1 52 percent would sometimes use a credit card, including 12 percent
who said they used credit cards all of the time.

If a discount of 3 percent

were to be offered, the proportion of those who would sometimes use a credit
card drops 20 percentage points to 31 percent of the card holders.

As shown,

each further increment in the hypothetical discount diverts additional respon
dents away from card use, but the largest shift occurs between no discount
at all and the 3 percent level.

At the highest level of discount discussed,

1. Those who never use credit cards, of course, might use other forms of
credit to finance such purchases, including cash loans from banks, credit
unions or other institutions.
The proceeds of such loans would finance
a "cash" transaction at the retail store.

-8415 percent of the card-holding respondents would use a card at least part
of the time, and 2 percent would still use one all of the time.
The bottom part of table 6.3 incorporates respondents who do not
have credit cards into the analysis.

When they are added into the "never

use card" column, an estimated 66 percent of all respondents would purchase
durables without using credit cards, even when no discount for cash were
offered.^

At a 3 percent discount for cash, 80 percent would entirely dis

pense with credit cards, and at the highest discount considered— 9 percent—
90 percent would never use a credit card.
Respondents indicated a more frequent use of credit cards for
clothing than for durable goods purchases.

In the initial "no discount"

situtation, 30 percent said they would never use a card to buy clothing.
a 3 percent discount, 53 percent would never use a card.

At the highest

discount considered, 81 percent would cease using a credit card entirely.
The comparison between durables and clothing as to non-use of cards is shown
in table 6.4.
Although a measurable shift from credit to cash appears likely, the
survey results, especially for durables, suggest that a discount-for-cash
program might be of limited cost effectiveness.

It appears that the offer of

a 3 percent discount may persuade 20 percent of the card-holding customer
base to switch from credit to cash, thus generating savings on credit costs.
But from 30 to 50 percent of the customer base that would pay cash anyway
would have to be given the same discount given to the "switchers," strongly
suggesting that the "credit price" in any two-tier system would have to be
above the regular price in a one-price system.
1. This estimate is likely biased upward to some extent in that the group
of respondents that have no credit cards may include some persons who buy
few or no consumer durable goods.

-85-

TABLE 6.3
USE OF CREDIT CARDS FOR PURCHASES OF FURNITURE AND APPLIANCES
AT VARIOUS LEVELS OF DISCOUNT FOR CASH

Discount
(Percent)

0
3
5
7
9

Discount
(Percent)
0
3
5
7
9

Responses as Percentage of Number of Card Holders
Would Use Card
||
Proportion of Time Would Use Card
1/2
Never
|
1/4
3/4
Sometime || None
11
48
22
12
6
48
52
||
8
16
2
69
69
31
1|
7
2
75
12
25
|1
75
9
82
5
2
82
18
||
3
1
9
85
15
11
85
!1

Responses as Percentage of All Respondents
| Would Use Card
Proportion of Time Would Use Card
1I
3/4
|
! Never
1
1/4
Sometime 11 None
1
1/2
|
66
80
84
88
90

34
20
16
12
10

11
11
11
1!
11
11

66
80
84
88
90

8
6
4
3
2

15
10
8
6
6

Responses from household survey, 1982.

TABLE 6.4
PROPORTION OF CREDIT CARD HOLDERS
THAT WOULD "NEVER" USE CARD

Discount
(percent)
0
3
5
7
9

1
|

Type of Purchase
I
Clothing
Durables
48
69
75
82
85

Responses from household survey, 1982.

30
53
64
74
81

4
1
2
1
1

All
12
5
4
3
2

All
8
3
3
2
1

-86Independent study of feasible discounts.

In a 1982 journal article,

C. Ingene and M. Levy! set out the conditions under which a discount for
cash can be advantageous to retailers and their customers, and used results
from a consumer survey on credit buying habits and attitudes toward discounts
to assess the feasibility of discount plans.
The authors began by presenting an equation for the "present value"
of the sales of a retail merchant.

The equation included terras for the pro

portions of sales on cash and third-party credit cards, respectively, as well
as the proportion of the sales price retained on cash sales (which varies
with the size of any discount for cash), and the proportion of the price
retained on credit card sales (which depends upon the factoring fee paid to
the card issuer and upon the number of days between the sale and the collec
tion of funds from the card issuer).

Given some cost of credit, the authors

observed that the optimal discount for cash depends upon the proportion of
credit customers that can be converted from credit to cash at various sized
discounts.^

All calculations were based on the assumption of an unchanged

regular price that becomes the credit price when discounts are introduced.
To make an empirical estimate of the extent to which discounts for
cash might induce customers to pay cash rather than use a credit card, Ingene
and Levy conducted a random telephone sample of 248 respondents in a major
southwestern metropolitan area.

The questions presented hypothetical

1. Charles A. Ingene and Michael Levy, "Cash Discounts to Retail Customers:
An Alternative to Credit Card Sales," Journal of Marketing, vol. 46 (Spring
1982), pp. 92-103.
2. This formulation ignores the possibility that a store offering a cash
discount might attract additional customers.
This outcome is excluded on
the grounds that, in equilibrium, competitive conditions would result in
other retailers offering similar discounts, negating the incentive for pro
spective customers to switch stores to obtain discounts.

87situations in which consumers were asked to report their intended purchase
behavior.

As the authors described the survey, "respondents were asked, for

example, if they would use a credit card or cash (or check) for a typical
$100 purchase.

If they indicated they would use a card, then the interviewer

asked if they would prefer to use their card on a $100 item or pay $97 in
cash or check; that is, would they accept a 3% discount.

If they chose to

use their card, they were asked if they would still use their card in lieu of
$96 in cash, a 4% discount."1

This iterative questioning procedure continued

until the respondent indicated a preference for paying cash, or until a
7 percent discount level was reached.

Part of the sample was asked questions

regarding a $100 purchase, and another part was asked about a hypothetical
$25 purchase.

These questions, while quite similar to the Federal Reserve

questions discussed earlier, differ from them in some respects.

For instance,

they concern purchases of a specified dollar amount rather than of particular
types of products.
For the case of a $100 purchase, only 12 percent of the respondents
indicated that they would typically not use a credit card; almost 90 percent
would use a card.^

In response to questions about discounts, only 8 percent

said they would not switch from credit to cash for a 7 percent discount.
Taking account of those that would have used cash without any discount and
those who would stick with credit cards despite cash discounts, it appeared
that 80 percent would switch from credit to cash for a discount of somewhere
between 2-1/2 and 7 percent.

At a discount of 3 percent, 50 percent of the

sample thought that they would use cash for a $100 purchase— the 12 percent
1. Ibid., p. 96 .
2. This proportion of credit users is far higher than indicated in the
Federal Reserve surveys, which may be partly due to the specification of
a dollar amount of purchase in the Ingene-Levy study.

-88who would always use cash and 38 percent who would switch to cash for a
discount of 3 percent.
When another set of respondents was asked about a $25 purchase,
34 percent indicated they normally would use cash (or check).

All but 4 per

cent of the panel would pay with cash at some level of discount.

Assuming

that the propensities uncovered in these surveys truly reflected conditions
faced by a typical retailer, the authors calculated that the optimal discount
for purchases in the $100 range would be about 3 percent, but that for $25
purchases optimal results would be achieved with no discount at all.
The statistical summary of the findings for a $100 purchase is
presented in table 6.5, reproduced from the Ingene and Levy article.

order r ■> calculate the present value of sales, it was necessary to determine
or assume the costs associated with cash and credit.

The authors assumed

that a retailer would pay a factoring fee of 5 percent to the card processor.
They also assumed a six-day lag between a credit card sale and collection
from the card processor, and used an interest rate of .05 percent per day to
figure the present value of such receipts.

The only explicit cost of cash

was the hypothetical discount, which varied from zero to 7 percent.
As the discount for cash increased, the present value of cash
sales would be diminished by the rising discount, offset to varying degrees
by the cost saving on factoring fees no longer required for sales diverted
from credit cards.

The table shows, for progressive levels of discount, the

proportion of people that would pay cash, and the calculated present value
of sales.

For the $100 case, peak profitability is reached at a 3 percent

discount.

The value of sales at a 4 percent discount sLill exceeds that at

the no-discount level by a small margin.

At higher discounts, the incremental

number of switchers is relatively small, resulting in little additional

-89reduction in credit-related costs, but a widening decline in revenues because
all cash customers must be given the higher discount.

TABLE 6.5
DISCOUNTED PRESENT VALUES FOR DISCOUNTS THAT
CONSUMERS REQUIRE TO PAY CASH RATHER THAN
USE CREDIT CARDS ON $100 PURCHASES

Discount
0
2-1/2
3
3-1/2
4
4-1/2
5
5-1/2
6
6-1/2

Cumulat ive
Proport ion
Paying Cash

Discounted
Present
Value as a
Percent
of Sales*

.1176
.2745
.5000
.5784
.5980
.7157
.8235
.8627
.8824
.9020

95.34
95.48
95.86
95.75
95.45
95.27
94.95
94.53
94.13
93.62

*Assuming a factoring fee of 5%, a daily interest rate
of .05% and a six-day lag between sales and collection
from the factor.
Source:

Ingene and Levy, "Cash Discounts to Retail
Customers," table 1, p. 97.

A crucial determinant of these results is the linkage between
the optimal discount and the size of the factoring fee.

The authors, as

noted, assumed a 5 percent factoring fee in their calculations, but a fee
of around 3 percent may now be more nearly typical, even for smaller
retailers, according to the Federal Reserve's retailer cost survey described
in Chapter 4.

When the lngene-Levy estimates of present value of sales are

recomputed for a 3 percent factoring fee, the benefit to the retailer of a
discount for cash (with unchanged regular price) disappears entirely, notwith
standing the high incidence of credit card use in the no-discount situation.

-90At a 3 percent discount for cash, the calculated present value of sales is
24 cents lower per $100 of sales than when no discount at all is given.
With a 4 percent factoring fee, the 3 percent discount for cash is optimal
by a small margin— by 13 cents per $100 of sales, compared with the no dis
count case.

Under these conditions, if the initial proportion of credit cus

tomers or the proportion of switchers from credit to cash were even slightly
overestimated in the surveys, the small remaining advantage to the retailer
from offering discounts could easily be eliminated.1

With apparently so

little to gain, then, it would not be surprising to find retailers hesitant
to undertake programs to offer discounts for cash.

Or that, if they do

oifer discounts, they adjust their structure of prices upward compared with
the single-price level.
Results of retailer poll on attitudes to two-tier pricing.

The

Federal Reserve's survey of retailers in April-May 1983 included a number of
questions about the extent to which retailers had adopted discount-for-cash
programs and about retailer attitudes toward such programs.

As will be

seen, discounts for cash were considerably more widespread among gasoline
retailers than among other retailers.

In both cases, however, the offering

of a discount for cash was not a typical practice.
Retailers offering a discount for cash were asked the size of the
discount, how the size of the discount was decided upon, whether the discount
was available for check payment as well as cash, what limitations (if any)
applied to the discount, whether the program was permanent or was a temporary
promotional measure, and whether the discount was automatically given to cash
1. Moreover, in this relatively simple model, the costs of cash and checks are
treated as equivalent, and payers by check also receive discounts.
In fact,
checks apparently are more costly to handle than cash.
Tf customers switching
from credit cards frequently choos? to pay by check, the gains to the retailer
would be minimized further.

-91customers or had to be requested.

Discount-for-cash retailers were also

asked what proportion of their customers received discounts for cash.
Retailers not offering discounts for cash at the time of the survey
were asked a series of questions about whether they had ever offered such a
discount and, if so, why they had discontinued the practice, or whether they
had ever considered offering such discounts and, if so, why they had decided
against it.

Remaining respondents were also asked why they chose not to

offer discounts for cash, and all non-discounting retailers were asked how
large a discount they thought they could offer (assuming no change in sales)
and still maintain the same level of profits.
Finally, all survey respondents were asked whether they thought it
a goodidea or a bad idea for

a retailer to offer a discount to customers who

pay in cash instead of by credit card, and respondents were probed for the
reasons behind their assessment.

They were also asked whether a surcharge

for credit was preferable to a discount for cash, and why.
Table 6.6 presents a listing of businesses offering discounts for
cash, and includes information on type of business, sales volume, proportion
of sales on credit card, size of merchant discount paid, and the size and
other characteristics of the discount for cash.

Summary statistics by size

and type of business are provided in table 6.7.
About one-fourth of the gasoline stations surveyed said that they
provided

discounts for use of cash.

Other providers of discounts were widely

scattered by type of business, representing about 6-1/2 percent of all non
gasoline retailers interviewed.
Aside from gasoline stations, lumber and building supply dealers
were most frequently found to offer discounts for cash.

Some dealers have

customarily provided building contractors with discounts for immediate cash

TABLE 6.6
SELECTED CHARACTERISTICS OF BUSINESSES OFFERING DISCOUNTS FOR CASH
Sales
Volume
($ thou.)

Type of
Bus iness

Lumber,
Lumber,
Lumber,
Lumber,
Lumber,
Lumber,
Lumber,

Bldg.
Bldg.
Bldg.
Bldg.
Bldg.
Bldg.
Bldg.

Supply
Supply
Supply
Supply
Supply
Supply
Supply

Paint, wallpaper
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas

Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations

Proport ion
of Sales on
Credit Card
Store 3rd-Party

Merchant
Discount
Paid

Size of
Discount
for Cash

Discount
Also for
Checks

118,000
1,000
3,000
3,000
2,000
1,100
29,000

—
—
—
—
—
—

20
5
1
5
79
1
3

3.0
1.9
3.0
5.5
3.5
2.0
5.0

n.a.
2.0
4.0
5.0
5.0
10.0
2.0

no
yes
yes
yes
yes
yes
no

1,060

—

3.5

10.0

50
40
—
—
5
20
—
—
—
—
—

—

5.0
5.0
3.5
3.0
3.5
5.0
3.5
3.0
3.0
3.5
3.0
3.0

900
1,100
5,990
17,000
156,000
1,500
3,000
1,500
1,000
9,000
750
4,000

10
5
20
3
10
10
20
30
30
40
20

4.0
3.0
n.a.
5.0
5.0
3.0
5.0
3.0
n.a.
5.0
4.0
4.0

Limitât ion
on
i
Cash Disc.

n.a.
—

Automatic
or
"Ask for"

Proportion
of Customer
Using

min.
mdse.
—
—
—

auto.
auto.
auto.
auto.
auto.
ask for
auto.

n.a.
95
10
70
21
50
100

yes

—

auto.

100

yes
no
yes
yes
yes
no
yes
yes
yes
yes
yes
yes

mdse .
—
n.a.
—
—
mdse.
mdse.
mdse.
n.a.
mdse.
—

auto.
auto.
auto.
auto.
auto.
auto.
auto.
auto.
auto.
auto
auto.
auto.

50
25
55
50
95
50
90
95
65
40
50
80

”
1. Discounts are limited to minimum size purchases (min.). to maximum size purchases (max.), or certain types of
merchandise (mdse.).
"n.a." means a response was not available.
means that no limitations were imposed on discount availability
Responses from survey of retailers, 1983

TABLE 6.6 (continued)
SELECTED CHARACTERISTICS OF BUSINESSES OFFERING DISCOUNTS FOR CASH

Type of
Bus ines s

Sales
Volume
($ thou.)

Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas
Gas

820
100
1,330
12,100
325
600
850
1,100
1,340
107,000

Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations
Stations

Apparel
Apparel
Appare1
Apparel
Appare1

437
30
381
40
10

Furn iture
Furniture
Furniture
Furniture
Furniture
Furniture
Furn iture

875
2,510
953
1,750
350
1,500
1,500

Floor Covering
Floor Covering
Floor Covering

700
3,000
600

Drapery & Upholstery

300

Proport ion
of Sales on
Credit Card
Store 3rd-Party
10
35
15
—
—
50
30
—
—
15
—

—
—
—
—
—

—
—
—
—
—
—

__
—
—
—

Merchant
Discount
Paid

Size of
Discount
for Cash

Discount
Also for
Checks

—
25
20
5
30
6
10
25

n.a.
3.0
3.0
4.0
3.0
3.0
n .a .
n .a .
3.0
n.a.

4.0
3.0
3.5
4.0
4.0
n.a.
3.0
3.5
3.0
3.5

yes
yes
yes
yes
no
yes
no
no
yes
no

8
20
10
3
7

2.5
n.a.
3.7
5.0
4.0

10.0
25.0
5.0
5.0
5.0

no
no
no
no
yes

5
5
2
1
10
15
10

3.0
3.0
4.0
2.0
2.0
1.5
4.0

5.0
3.0
10.0
2.0
2.0
5.0
n.a.

yes
yes
yes
no
yes
yes
yes

5
5
5

4.0
2.5
2.7

5.0
2.0
4.5

yes
yes
no

-—

2.5

5.0

yes

—

Limitât ion
on
Cash Disc.

Automat ic
or
"Ask for"

Proport ion
of Customer
Using Disc.

auto.
auto.
auto.
auto.
auto.
auto.
auto.
auto.
auto.
auto.

90
90
30
50
60
40
60
93
37
70

max.
mdes .
—
—
min.

auto.
auto.
auto.
ask for
auto.

n.a.
65
100
5
90

—
—
—
—
max.
mdse .
—

ask for
auto.
auto.
auto.
auto.
auto.
ask for

n.a.
70
100
n.a.
5
15
n.a.

ask for
auto.
ask for

70
100
5

ask for

min.
—
—
mdse.
mdse.
mdse.
—
mdse.
—
mdse.

—

TABLE 6.6 (continued)
SELECTED CHARACTERISTICS OF BUSINESSES OFFERING DISCOUNTS FOR CASH

Type of
Business

Sales
Volume
($ thou.)

Proportion
of Sales on
Credit Card
Store 3rd-Party

Appliance & TV
Appliance & TV
Appliance & TV

700
293
32

—
—
—-

Music
Music
Music

220
47
385

—

Drug Stores
Drug Stores

100
800

Sporting Goods

750

—

791
8,500

—

Stat ionery
Stat ionery
Jewelers
Jewelers

359
865

—
—
—
—

—

- -

—

•

Merchant
Discount
Paid

Size of
Discount
for Cash

Discount
Also for
Checks

Limitat ion
on
Cash Disc.

15
5
2

2.5
2.0
5.0

2.0
n.a.
10.0

yes
yes
no

mdse.
mdse.

1
4
1

4.7
4.0
3.0

4.0
4.0
5.0

no
yes
yes

min.
mdse.

2
1

4.0
5.0

4.0
10.0

no
no

2.0

3.0

1
5

4.0
4.0

10.0
3.5

yes
yes

45
40

3.0
3.0

10.0
5.0

no
no

—

— —

mdse.
—
min.
mdes.
_____

—

Automat ic
or
"Ask for"

Proportion
of Customer
Using Disc.

ask for
ask for
ask for

30
50
60

auto.
auto.
auto.

50
50
80

ask for
auto.

1
6

auto.

auto
auto.

13
20

auto.
ask for

45
5

-95payment (or, commonly, for payment within 10 days), which may be reflected
in the high incidence of reported discounts in this group.

Among other types

of retailers, discounts of 10 percent were fairly common and one retailer
reported a 25 percent discount.

This latter respondent may have been citing

a broader discount pricing approach,

in that a discount of 25 percent is

likely much larger than the cost saving realizable from shifting some custo
mers to cash from credit cards.

The discounts of 10 percent also appear

larger than supportable by cost differences alone, and thus may partly
reflect expectations of or attempts to gain increased sales.

Nevertheless,

insofar as such discounts are tied to use of cash and not available to
credit card users, they are appropriately treated as discounts for cash.
Summary statistics (table 6.7) show that the average size of the
discounts for cash was just under 4 percent at gasoline stations and nearly
6 percent at other types of retailers (column 6).

At 62 percent of the

gasoline stations and at 43 percent of other retailers, a size-of-purchase
or type-of-merchandise restriction limited eligibility for the discount
(column 9).

Several retailers— 27 percent of the gas stations and 38 percent

of the other retailers— excluded check transactions from their discount
offer (column 8).

The discount was automatically available at all of the

gasoline stations, but had to be requested at a third of the other retailers
(column 7), indicating that the availability of discounts in several cases
was narrower than contemplated in the Cash Discount Act.
Among other statistics of note, average factoring fees paid to
credit card issuers were slightly higher at retailers that offered discounts
(3.4 percent) than at card-honoring retailers generally (3.1 percent, from

1. Some "discount stores," for instance, advertise goods at prices substantially
lower than a specified list price or one described as commonly available.

TABLE 6.7
PROPORTION OF RETAILERS OFFERING DISCOUNTS FOR CASH AND
SELECTED STATISTICS BY TYPE AND SIZE OF RETAILER

Categories of
Retailers

1
I Total
|Number of
|Respondents
(1)

712

8.6

10.7

3.4

5.1

23.9

26.2

3.5

3.8

620

6.3

8.0

3.3

5.8

6.3

13.2

4.5

9.8

$100-999 thousand

270

6.7

8.4

3.1

5.9

$1 - 9.99 million

169

7.7

9.1

3.1

4.6

100

3.3

9.7

4.0

2.6

All Retailers
Gas Stations
All Other
All other, by sales
Less than $100 thousand

$10 - 99.9 million
$100 million and over
1. Limits most commonly mentioned included restrictions on the type of merchandise eligible for discounts or on the
minimum size of purchase to which a discount would be applied.
Responses from survey of retailers, 1983.

-97table 4.9).

The proportion of sales on credit cards at discount-offering

retailers was somewhat lower than average.
Table 6.7 also indicates that the size of the discount for cash
tended to vary with the size (sales volume) of the retailer, although the
small number of observations limits the confidence that can be accorded the
size-group breakdown.

Still, differences in average discounts for cash among

retailers of different size were rather striking.

The pattern of difference

is consistent with the factoring fee structure for credit cards whereby
smaller merchants pay larger fees (and therefore have a greater incentive to
offer larger discounts for cash).
The propensity of smaller merchants to give larger discounts is
also consistent with the responses given by non-discounting merchants to the
question of how large a discount they thought that they could offer and still
maintain a given level of profits.

Shown in table 6.8, this distribution

of estimated "equal-profit" discounts shows smaller differences among retailer
size groups, but the inverse association of size of business with size of
discount holds across all categories of retailer.
Table 6.9 provides certain information about the retailers that
reported not offering discounts for cash.

A small number (about 4 percent

of all respondents) once offered discounts for cash, but no longer do so.

larger group (about 18 percent) said they had considered offering discounts
for cash, but had decided against such an action.

Of those retailers that

were not offering discounts, therefore, the majority had not seriously con
sidered such an option.

All retailers in these categories were asked why

they were not offering discounts for cash.

Responses are shown in the table

for gasoline stations and all other retailers separately.

-98In general, there were few major differences among the categories
of retailers in reasons for not offering discounts for cash.

Many reasons

were mentioned, with no single reason dominating the responses.

Most often

mentioned was the lack of need for such a measure, frequently because little
or no business was transacted by credit card.

Mentioned almost as often was

the view that a discount for cash would be "too costly," would "cut profits,"
or might "start price wars."

Several different reasons were mentioned by

about 7 to 10 percent of the respondents.

These included the assertions

that discounts were "too confusing” or that "customers don't like" them,
that discounts are "unfair" or "discriminatory" to some customers, and that
the retailer might "lose sales" or "not gain any sales" by offering discounts.
Bookkeeping and paperwork problems were mentioned by several gas stations
but by only a few retailers in other lines of business.

TABLE 6.8
ACTUAL AND POSSIBLE DISCOUNTS FOR CASH AT NON-GASOLINE RETAILERS

Sales Categories
of Retailers

Actual Discounts
for Retailers
That Offer
Discounts

Possible Discount
With Unchanged
Profits for
Non-discounters

Less than $100 thousand

9.8

5.3

$100 - 999 thousand

5.9

4.5

$1 - 9.99 million

4.6

3.7
2.5

$10 - 99.9 million
2.6
$100 million and over
Responses from survey of retailers, 1983.

2.2

TABLE 6.9
REASONS GIVEN BY RETAILERS NOT OFFERING DISCOUNTS FOR CASH

Categories of
Retailers

1
1 Number
1 of Re1tailers

Used to Offer Discount,
Don't Now

Gas Stations
All Other

4
16

Have Considered, Don't
Offer Discount

Gas Stations
All Other

15
74

13
19

20
16

7
8

391

45
346

24
34

29
20

9
6

7
6

Others not Offering
Di scount
Gas Stations
All Others

Responses from survey of retailers, 1983.

—

13
12

33
4

13
26

7
11

11
2

13
18

(too few observations, proportions not meaningful)
44
—
6

_
3

-100All survey respondents were asked whether they thought it a good
idea or a bad idea for a retailer to offer discounts for cash.
responses, with the reasons given, are shown in table 6.10.

These

While questions

of this theoretical open-ended nature warrant conservative interpretation,
the proportion labeling discounts a "good idea" is nevertheless impressively
high at 41 percent of the panel.

The figure is somewhat surprising in view

of the far smaller number of retailers that actually offer discounts for
cash.

It may be that some respondents believe discounts are a good idea for

retailers generally but, for some reason, not in their own situation.

likely, the assessments mainly reflect spontaneous reactions to an issue
by respondents who had given it little serious thought before,^ a situation
that might tend to yield a relatively even division between "good" and "bad"
assessments.
In view of the higher proportion of gas stations offering discounts
than of other types of retailers, it is anomalous that a smaller proportion
of gas stations viewed discounts favorably (34 percent) than was the case
among other retailers (42 percent).

Curiously, among the 21 gas stations

actually offering discounts, 9 described that policy as a "bad idea."

Rea

sons for regarding discounts as a "good idea" were rather evenly divided
among such benefits as improved cash flow, generation of incremental sales
or profits, a sense of fairness to cash-using customers, and better coverage
of credit card costs.
How non-gasoline retailers of different size regarded the practice
of giving discounts for cash is shown in Table 6.11.

Clearly, smaller

retailers were more likely to view discounts favorably; those in the lowest
1. As table 6.9 shows, only about 22 percent of retailers not offering dis
counts for cash had ever considered doing so (or had actually done so).

-101sales category were twice as likely to term discounts a good idea as were
retailers in the highest sales category.

This result is, of course, con

sistent with findings already presented that higher proportions of smaller
retailers provide discounts for cash, that they pay higher factoring fees
to card issuers, and offer larger discounts for cash.
TABLE 6.10
ASSESSMENT OF DISCOUNT FOR CASH AS GOOD OR BAD IDEA, WITH REASONS CITED

1 Proportion^

Reasons for Regarding as Good Idea
( percent of "good" responses)
Attract
Fair | Cover Cost
r
Customers;
Increase I
to
| of Cards;
Profits | Customer| Reduce Fees
Sales Higher

Categories
of Retailers

1 Responding
i "Good Idea"

Better Cash
Flow; Prompter
Receipt

All Retailers

34
42

16
15

19
13

—

29
10

Gas Stations
All Others

Reasons for
1
1
(percent
I
1
Unfair to
1 Proportion^ | Too Costly; I
I Responding I Cut Profits; I
Customer;
| "Bad Idea" I Price Wars | Discriminates

Categories
of Retailers
All Retailers
Gas Stations
All Other

Regarding as Bad Idea
of "bad" res ponses)
| Confusion; 1 No Need;
1 Customers 1 Not Many
| Don't Like 1 Card Sales

Might Lose
Sales; No
Sales Gain

66
56

17
24

25
19

13
15

3
13

12
7

u ‘ , idea"
• _i" 11------Tj — n— and
:_ i IT'*bad
Ti Proportions of“ Ti------"goodT “ idea"
responses do not add to 100 percent within particular categories because of "don't know" responses.

Responser from survey of retailers, 1983.

Finally, respondents were asked whether, instead of a discount for
cash, adding an extra fee when customers use credit cards was a good idea
or a bad idea.

(Results are shown in table 6.12.)

Twenty-nine percent of

all respondents who answered the question thought that surcharges for credit

TABLE 6.11
ASSESSMENT OF DISCOUNT FOR CASH AS GOOD OR BAD IDEA BY SIZE OF RETAILER

Category of Retailer
By Sales Volume
All Respondents

1
|
I

Total
Non-Gasoline
Respondents

I
I
I

Number Citing
Discounts for Cash As:
Good Idea I Bad Idea

I
1
1

Proportion Citing
Discounts for Cash As:
Good Idea
Bad Idea

613

257

341

41.9

55.6

50.0

47.5

$100 - 999 thousand

266

113

144

42.5

54.1

$1 - 9.99 million

168

43.5

56.0

$10 - 99.9 million

35.7

62.5

$100 million & over

24.4

70.7

Less than $100 thouand

Responses from survey of retailers, 1983.

-103represented a better approach to two-tier pricing than did discounts for
cash.l

Among non-gasoline retailers, smaller businesses were more likely

than large businesses to regard surcharges as a better idea than discounts.
On the whole, it did not appear that authorization of surcharges would have
a major impact on the frequency of two-tier pricing.

As indicated in previous

tables, 42 percent of non-gasoline retailers described discounts for cash as
a good idea, but only 6-1/4 percent actually were offering discounts in the
spring of 1983.

Judging from these results, if about 6 percent of those who

thought surcharges to be the better approach would adopt two-tier pricing,
an additional 2 percent of all non-gasoline retailers would employ a two-tier
system.

TABLE 6.12
RETAILER COMPARISON OF CREDIT CARD SURCHARGE TO CASH DISCOUNT

Type of Retailer and
Volume of Sales Categories
All Retailers
Gasoline Stations
All Other
Less than $100 thousand
$100 - 999 thousand
$1 - 9.99 million
$10 - 9.99 million
$100 million and over

Number
of
| Respondents

j
I

Percentage of Retailers
That Said Surcharge Good
or Bad Idea Compared to
Discount for Cash
Good Idea
I
Bad Idea

700

611
78
267
167
55
42

28
41
31
21
20
26

72
59
69
79
80
74

Responses from survey of retailers, 1983.

1. It made little difference whether the respondent had previously described
discounts as a good idea or a bad idea.

BIBLIOGRAPHY

Board of Governors of the Federal Reserve System.
Check-Credit Plans. Washington, 1968.

Bank Credit-Card and

Durkin, Thomas A., and Gregory E. Elliehausen.
1977 Consumer Credit Survey.
Washington:
Board of Governors of the Federal Reserve System, 1978.
Federal Reserve Bank of Boston.
editions.

Functional Cost Analysis.

Boston, annual

Flannery, Mark J., and Dwight M. Jaffee. The Economic Implications of an
Electronic Monetary Transfer System. Lexington, Mass: Lexington Books,
1973.
Garcia, Gillian.
"A Note on Bank Credit Cards' Impact on Household Money
Holdings," Journal of Economics and Business, vol. 29 (Winter 1977),
pp. 152-54.
__________ . "Bank Credit Cards, Time Deposits, and M2," Journal of Economics
and Business, vol. 30 (Spring/Summer 1978), pp. 230-35.
_. "Credit Cards:
An Interdisciplinary Survey," Journal of Consumer
Research, vol. 6 (March 1980), pp. 327-37.
Gordon, G.G., and others. The Impact of a Consumer Credit Interest Limitation
Law.
Seattle: Graduate School of Business, University of Washington,
1970.
Grant, Robert M. "Transaction Costs to Retailers of Different Methods of
Payment.
Result of a Pilot Study." Processed. Report prepared at The
City University, London, 1982.
Gushee, Charles H . , ed. The Cost of Personal Borrowing in the United States.
Boston:
Financial Publishing Company, 1979, 1982.
Ingene, Charles A., and Michael Levy. "Cash Discounts to Retail Customers:
An Alternative to Credit Card Sales," Journal of Marketing, vol. 46
(Spring 1982), pp. 92-103.
Johnson, Robert W. Retailers: CRC 1979 Creditor Survey. West Lafayette,
Ind.: Krannert Graduate School of Management, Purdue University, 1980.
Katona, George, Lewis Mandell, and Jay Schmiedeskamp. 1970 Survey of Consumer
Finances. Ann Arbor, Mich.: Survey Research Center, Institute for
Social Research, University of Michigan, 1971.
Lynch, Gene C. "Consumer Credit at Ten Per Cent Simple: The Arkansas Case,"
University of Illinois Law Review (1968), pp. 592-601.

-2Mandell, Lewis, and others.
Surveys of Consumers:
1971-72. Ann Arbor,
Mich.: Institute for Social Research, University of Michigan, 1973.
Marcus, Edward.
"The Impact of Credit Cards on Demand Deposit Utilization,"
Southern Economic Journal, vol. 26 (April 1960), pp. 314-16.
McAlister, E. Ray and Edward DeSpain. An Empirical Analysis of Retail Revolving
Credit. West Lafayette, Ind.: Krannert Graduate School of Management,
Purdue University, Monograph No. 1, 1975.
Miller, Stephen M. "The Money Supply Process and Credit Card Use: An Empirical
Analysis," E astern Economic Journal, vol. 8 (April 1982), pp. 89-99.
Montgomery, Edward B. "Tests of Alternative Explanations of the Decline in
the Personal Saving Rate." Ph.D. dissertation, Harvard University, 1982.
National Commission on Consumer Finance. Consumer Credit in the United
States. Washington: Government Printing Office, 1972.
Payments Systems, Inc.
Russell, Thomas.

Cost of Cash:

A Strategic Analysis.

The Economics of Bank Credit Cards.

Atlanta, 1981.

New York: Praeger, 1975.

Shay, Robert P . , and William C. Dunkelberg.
Retail Store Credit Card Use in
New York. New York: Graduate School of Business, Columbia University,
Studies in Consumer Credit, No. 4, 1975.
Touche Ross & Co. "Economics of New York State Retail Store Revolving Credit
Operations for the Fiscal Year Ended January 31, 1973," in Robert P.
Shay and William C. Dunkelberg, Retail Store Credit Card Use in New
York. New York: Graduate School of Business, Columbia University,
Studies in Consumer Credit, No. 4, 1975.
White, Kenneth.
"Consumer Choice and Use of Bank Credit Cards: A Model and
Cross-Section Results," Journal of Consumer Research, vol. 2 (January
1975), pp. 10-18.

APPENDIX A
TEXT OF CASH DISCOUNT ACT OF 1981

95 STAT. 144

PUBLIC LAW 97-25—JULY 27, 1981
P ublic Law 97-25
97 th C ongress

July 27, 1981

;h .r. :iij

A n A ct

To amend the Truth in Lending Act to encourage cash discounts, and for other
purposes.

Be it enacted by the Senate and House of Representatives o f the
United States of America in Congress assembled, That this Act may be
Act
cited as the “Cash Discount Act”
15USC 1601
note
TITLE I—CASH DISCOUNTS
S e c . 101. Section 167(b) of the Truth in Lending Act (15 U.S.C.
1666f(b)) is amended to read as follows:
“(b) With respect to any sales transaction, any discount from the
regular price offered by the seller for the purpose of inducing
payment by cash, checks, or other means not involving the use of an
open-end credit plan or a credit card shall not constitute a finance
15USC 1605.
charge as determined under section 106 if such discount is offered to
all prospective buyers and its availability is disclosed clearly and
conspicuously.”.
Sec .102. (a) Section 103 of the Truth in Lending Act (15 U.S.C. 1602)
is amended by adding at the end thereof the following:
“Regular price.’’ “(z) As used in this section and section 167, the term ‘regular price’
means the tag or posted price charged for the property or service if a
single price is tagged or posted, or the price charged for the property
or service when payment is made by use of an open-end credit plan or
a credit card if either (1) no price is tagged or posted, or (2) two prices
are tagged or posted, one of which is charged when payment is made
by use of an open-end credit plan or a credit card and the other when
payment is made by use of cash, check, or similar means. For
purposes of this definition, payment by check, draft, or other negoti
able instrument which may result in the debiting of an open-end credit
plan or a credit cardholder’s open-end account shall not be considered
payment made by use of the plan or the account.”.
15USC 1602
(b) Effective April 10,1982—
note.
(1) subsections (x) and (y) of section 103 of the Truth in Lending
94Stat J69.
Act (as redesignated by section 603(b) of Public Law 96-221) are
redesignated as subsections (y) and (z), respectively; and
(2) subsection (z) of such section (as added by subsection (a)) is
redesignated as subsection (x) and is inserted after subsection (w).
15USC 1666f
S ec . 103. Any rule or regulation of the Board of Governors of the
note.
Federal Reserve System pursuant to section 167(b) of the Truth in
Supia.
Lending Act, as such section was in effect on the day before the date
of enactment of this Act, is null and void.
TITLE II—BAN ON CREDIT CARD SURCHARGES
S ec. 201. Section 3(cX2) of Public Law 94-222 (15 U.S.C. 1666f note)
is amended to read as follows:
“(2) The amendments made by paragraph (1) shall cease to be
effective on February 27,1984.”.
Cash Discount

-A-2

PUBLIC LAW 97-25—JULY 27, 1981
Sec .202. Not later than two years.after the date of enactment of
this Act, the Board of Governors of the Federal Reserve System shall
prepare a study, on the basis of a review and analysis of such data and
studies as it finds appropriate, and shall submit its findings to the
Committee on Banking, Housing, and Urban Affairs of the Senate
and the Committee on Banking, Finance and Urban Affairs of the
House of Representatives on the effect of charge card transactions
upon card issuers, merchants, and consumers, including to the extent
possible—
(1) the effects of charge card transactions on retail sales;
(2) the effect of charge card usage on consumers and on
merchants, including the effects on merchant cost; and
(3) the effect of charge card usage on the pricing of goods and
services, with a comparison of the costs resulting from payment
by (A) currency and coin, (B) by personal check or similar
instrument, (C) by in-house credit plans, and (O) by charge card.
TITLE HI-MISCELLANEOUS
S ec . 301. Section 625(c) of Public Law 96-221 is amended by adding
at the end thereof the following: “Any creditor who elects to comply
with such amendments and any assignee of such a creditor shall lie
subject to the provisions of sections 130 and 131 of the Truth in
Lending Act, as amended by sections 615 and 616, respectively, of this
title.”.
Sec . 302. Section 5137 of the Revised Statutes (12 U.S.C. 29) is
amended by adding at the end thereof the following new paragraph:
“Notwithstanding any other provision of this section, any national
banking association which, on the date of enactment of this para
graph, held title to and possession of real estate which was carried on
the association’s books at a nominal value on December 31,1979, may
continue to hold such real estate until December 31, 1982, if the
earnings from such real estate are separately disclosed in the finan
cial statements of the association.”.
Sec . 303. (a) Section 204 of the Public Health Service Act is
amended bv inserting after the first sentence the following new
sentence: “The President may appoint to the office of Surgeon
General an individual who is sixty-four years of age or older.”.
(b) Section 211(a)(1) of such Act is amended by adding at the end
thereof the following new sentence: “This paragraph does not apply
to the Surgeon General of the United States.”.
Approved July 27, 1981.

LEGISLATIVE HISTORY— H R.31 (HR 3132)(S.414):
HOUSE REPORT No. 97-159(Comm, ofConference).
SENATE REPORT No 97-23AccompanyingS.414(Comm, on Banking, Housing,and
Urban Affairs)
CONGRESSIONAL RECORD, Voi. 1270981):
Feb.24,consideredand passedHouse.
Mar. 5,S 414 considered inSenate.
Mar. 12,considered and passedSenate,amended, inlieuofS 414
May 4,H.R. 3132consideredand passed House.
May 20,June 24,House consideredand agreed toconferencereport.
July 14,Senateagreedtoconferencereport.

95 STAT. 145
Study findings,
submittalto
congressional
committees.
15USC 1601
note.

94Stat.185.
15USC 1602
note.
94 Stat.180, 182.
15USC 1640,
1641.
94Stat. 186.

42USC 205.
Presidential
appointee.
42 USC 212.

APPENDIX B
FEDERAL RESERVE SURVEYS ON CREDIT CARDS AND RELATED MATERIALS

The Federal Reserve Board has sponsored a number of consumer and
retailer surveys, mentioned in the text of this report, that focus on credit
cards to some extent.

Three surveys— two of consumers in 1982 and 1983,

and one of retailers in 1983— were designed specifically to address issues
discussed in the report.

All of the consumer and retailer surveys summarized

below were conducted on behalf of the Federal Reserve Board by the Survey
Research Center (SRC), Institute for Social Research, University of Michigan.
In addition, the Federal Reserve Board initiated, and served as a joint
sponsor of, a benchmark Survey of Consumer Finances in 1983.

Information

from over 4,000 households was collected by SRC mainly in the spring and
summer of 1983.

Results are not yet available.

1977 Consumer Credit Survey.

A survey of 2,563 households, con

ducted in August and September of 1977, explored consumer use of different
types of credit, and measured consumer awareness, understanding, attitudes,
and behavior regarding credit and its regulation.

Field work was jointly

sponsored by the Federal Reserve Board, the Office of the Comptroller of the
Currency, and the Federal Deposit Insurance Corporation.

An analysis of the

information obtained in the survey was published in Thomas A. Durkin and
Gregory E. Elliehausen, 1977 Consumer Credit Survey (Washington:

Board of

Governors of the Federal Reserve System, December 1978).
1978 Follow-up Survey of Consumers.

In August and November of

1978, SRC conducted reinterviews with many of the same households questioned
in the 1977 Consumer Credit Survey.

An analysis of some of the reinterview

findings appeared in Charles A. Luckett, "Household Financial Behavior:

-B-2Implications for Consumer Spending," West Lafayette, Ind.:

Krannert Graduate

School, Credit Research Center Working Paper No. 37 (1980).
Consumer holding and use of credit cards.

On several occasions in

1981, 1982, and 1983, SRC included a set of Board-sponsored questions on
credit card holdings and use in its regular monthly Survey of Consumer
Attitudes that covers about 700 households.

Results appear at various places

in this report.
Consumer reactions to discounts for cash.

In October 1982 SRC

included a set of Board-sponsored questions about cash discounts in its
regular monthly Survey of Consumer Attitudes.

Approximately 700 households

were queried about their reactions to discounts for cash on purchases of
furniture and appliances and clothing through a series of questions about
certain hypothetical situations.

Results are discussed in Chapter 6 of this

report.
Means of payment for gasoline purchases.

In its January 1983 Survey

of Consumer Attitudes, SRC asked approximately 700 households a set of Boardsponsored questions about consumer use of credit cards to purchase gasoline,
and about consumer experience with discounts for cash in buying gasoline.
Results are discussed in Chapter 6 of this report.
Retailer credit policy.

SRC conducted a Board-sponsored survey in

April-May 1983 of a sample of retail organizations, primarily to develop
information about relative costs to merchants of cash, check, and credit
card transactions, merchant preferences regarding these modes of transac
tions, merchant experience with cash discounts, and merchant attitudes toward
discounts for cash and surcharges for credit.
The survey was based on telephone interviews with 713 retail
establishments selected as a stratified random sample among types of firms

-B-3likely to accept several means of payment, including credit cards.

The study

population encompassed all retail establishments in the coterminous United
States with a primary Standard Industrial Classification code from one of
the following categories:

52 (building materials and garden supplies),

except 527 (mobile home dealers); 53 (general merchandise stores); 553 (auto
and home supply stores); 554 (gasoline service stations); 56 (apparel and
accessory stores); 57 (furniture and home furnishing stores); 591 (drug
stores and proprietary stores); 594 (miscellaneous shopping good stores);
5961 (mail order houses); 5983 (fuel oil dealers); 5984 (liquefied petroleum
gas dealers); and 5992 (florists).

Results of the survey are discussed in

various places in this report, especially Chapters 4 and 6.
Other Federal Reserve materials on credit cards.

In 1968, a Federal

Reserye System Report was published on Bank Credit-Card and Check-Credit Plans
(July 1968).

At the end of 1972, the Bank Report of Condition contained a

special statistical supplement on credit cards, analyzed by David F. Seiders
in "Credit-Card and Check-Credit Plans at Commercial Banks," Federal Reserve
Bulletin (September 1973), pp. 646-53.

In addition, in its monthly statistical

release entitled "Consumer Installment Credit" (G.19), the Federal Reserve
Board regularly publishes estimates of the amount of revolving credit at
commercial banks, gasoline companies, and retailers.

APPENDIX C
HYPOTHETICAL EXAMPLE OF TWO-TIER PRICING OF GASOLINE
This Appendix presents a hypothetical^ example of gasoline pricing
before and after adoption of a discount-for-cash program.

The example assumes

that there are no shifts in underlying wholesale gasoline prices, that sales
volume remains constant, and that the gasoline retailer has an objective of
maintaining a constant level of profits.^

The purpose of the example is to

indicate the relationship that could be expected between a former single
price for gasoline and a new two-tier set of prices, using estimates about
certain aspects of buyer behavior that were discussed in Chapter 6, section 2.
The example, shown in table C.l, is constructed with 100 customers
each buying one gallon of gasoline.

Drawing on the household survey results,

the assumption is made that about 40 customers would use credit cards and
60 would pay in cash in the absence of a discount offer.

For sake of illus

tration, it is assumed that gross receipts of $120 would cover all costs,
including credit card costs, and yield the gasoline seller some desired
level of profits.

Obviously, under a single-price system, the retail price

of a gallon of gas would be $1.20 to each customer.
Introduction of a discount-for-cash policy complicates the price
structure.

In line with the discussion in Chapter 6 and statistics in

table 6.2, when a discount is offered, the proportions of cash and credit
buyers are assumed to shift from .60 and .40, respectively, to .75 and .25.
1. It is recognized that the introduction of a discount-for-cash program may
affect a station's volume of sales, at least at first. The station may hope
to increase sales by attracting cash users away from competitors. But— to
repeat a point made elsewhere in this report— competitive response by other
stations is likely to minimize any sales advantage initially accruing to a
dealer that sets up a two-tier system. Unless two-tier pricing were to
stimulate total industry-wide gasoline sales, it would be inappropriate to
assume some permanent sales gain for any particular retailer.

-02In the present example, then, 75 persons would buy for cash and 25 would use
a credit card under two-tier pricing, for a net shift of 15 customers from
credit to cash.

Since this shift would reduce the seller's cost of carrying

receivables, the gross revenue needed to maintain level profits would drop by
15 times the per gallon cost saving.

In the example, a credit-handling cost

of 3 cents per gallon of gas sold on credit is used, which approximates the
cost estimated by several major gasoline companies.

By influencing 15 cus

tomers to switch from credit card to cash, the gas station in the example
could save 45 cents in credit servicing costs, thus reducing the level of
gross revenues needed to maintain constant profits to $119.55 from $120.
Assuming that the cash price and credit price would be set to differ
by the amount of credit-related c o s t s per gallon, it can be calculated (as
shown in table C.l) that the gasoline seller would need to price gas at
$1,188 for cash sales and $1,218 for credit sales.1

Because the lower price

for cash must be offered to those who would pay cash anyway, the cash price
cannot be reduced from the old $1.20 price by the full amount of the per
gallon cost of credit.

Instead, the two-tier price would points bracket the

old single price point.
Retail gasoline prices in the real world often fluctuate a few
cents from week to week.

Thus it is difficult to judge how closely an

actual station's two-tier price structure vis-a-vis an alternative single
price policy might compare with the example sketched here.

However, as noted,

1. Alternatively, rather than assuming a price differential equal to the
difference in cost between credit card and cash transactions, then solving
for the two prices, one could assume the credit price to be set equal
to the price that would be charged in a one-tier system ($1.20 in this
example), then solve the equations for the cash price. Under this approach,
it can be calculated that, given the credit price of $1.20 in the two-tier
system, the cash price would have to be at least $1,194 to maintain the
target level of profits.

-03values of the key variables in the example were chosen--based on survey
results— to realistically reflect conditions faced by typical gasoline
retailers.

Moreover, as further calculations under alternative assumptions

would show, the implications of the example do not depend narrowly on the
specific values of the variables used.

That is, under widely different

customer purchasing habits, the new two-tier price schedule would still
bracket the old one-tier price.

For instance, if it were assumed that

as many as 60 percent (instead of 40 percent) of the customers would use
credit cards in a single-price system, and that only 20 percent would use
credit cards in a two-tier system,1 the "equal-profit" prices would be $1,182
for cash and $1,212 for credit, compared with the one-tier price of $1.20.
1. In other words, 40 percent of the total customer base would switch from
credit card to cash in this alternative, compared with 15 percent who switched
in the original example.

-04TABLE C.l
HYPOTHETICAL GASOLINE PRICING WITH CONSTANT PROFITS
UNDER ONE-TIER AND TWO-TIER PRICING SCHEMES

_____ Single-price case_____
aX + bY = R
X -

____ Two-tier pricing:
revenue function

Y = 0

(a+s) X + (b-s) Y = R - cs

price structure

X = Y - c

calculations :
60 X + 40Y = $120
X - Y = 0
100 X = $120
X = $
Y = $

where :

X
Y
a
b
R
s
c

=
=
=
=
=
=
=

1.20
1.20

X +
____

25 Y = $119.55
X - Y = - $ .03
100 X = $118.80
X = $ 1.188
Y = $ 1.218

cash price
credit price
number of customers per 100 that typically pays cash
number of customers per 100 that typically uses credit card
desired gross revenue for initial cash/credit sales mix
number of customers that shifts to cash from credit
cost of financing receivables per gallon of gas sold on credit

assumptions:

(60+s)X + (40-s)Y = $120 - $.03s
X - Y =
-c

a = 60, b = 40
R = $120
s = 15
c = .03
each customer buys one gallon of gas

Full text of Credit Cards in the U.S. Economy : Their Impact on Costs, Prices, and Retail Sales

FRASER