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## Ch8 Banks and Money

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**Ch8 Banks and Money**指 導 老 師：李 永 銘 老師 學 生：李 珮 鈺 9464505 楊 仁 宏 9464518 黃 昭 容 9464521 李 淑 君 9564505 日 期：2006.11.16**Outline**• Switching Costs and Competition • A model of switching costs and fee competition • Empirical estimations of switching costs • Automatic Teller Machines (ATMs) • A model of banks competition with ATMs • Incompatible ATMs • Compatible ATMs • One –way compatibility • Media of Exchange as Network • Money and network effects • Coexistence of different payment instruments**A model of switching costs and fee competition**Step1: Let: :the fee charged by bank i :the cost of switching from bank i to a new account in a different bank :the utility of a consumer served by bank i Step2: The profile of bank i ,as a function of fee charged and the number of accounts is:**A model of switching costs and fee competition**Step3: We index the banks so that 1 has the largest number of accounts, bank 2 has the second-largest number of accounts, and so on Step4:**A model of switching costs and fee competition**Step5: The fees are observed, we can now solve for the unobserved switching costs of the customers of each bank. Step6: The smallest bank assumes that it is targeted by bank 1, it maximizes Step7: Since and are observed, we can solve for the unobserved remaining switching cost**Empirical estimations of switching costs-In the market for**demand deposits The Finnish banking industry 1997.All figures are in $U.S. Lifetime discounted sum of fees are based on a 4% real interest rate.**Empirical estimations of switching costs-In the market for**demand deposits • The large banks in general serve customers with high switching cost. • The smallest bank serves customer with no switching cost. • Switching costs account for between 0% to 11% of average balance a depositor maintains with the bank.**Empirical estimations of switching costs-In the market for**loans • Switching costs decline with the size of the bank as measured by the number of branches each bank maintains .**Empirical estimations of switching costs-Deposit accounts**versus the market for loans • Deposit-account market, switching costs tend to rise with the size of the bank as measured by the number of accounts. • Market for loans, switching costs tend to decline with the size of the bank as measured either by the number of branches or the total loan size.**A model of banks competition with ATMs**Let: :the fee charged to each bank i account holder :the cost to a customer who switching from bank to another. :the utility of a consumer served by bank i :the number of ATMs of A bank**Incompatible ATMs**• Definition Bank i is said to be undercutting the fee set by bank j if bank i reduces its fee so that all the customers of bank j switch to bank i .**Incompatible ATMs**Bank A sets the highest subject to the constraint that bank B will not find it profitable to undercut .Formally, is determined by Similarly, is determined by**Incompatible ATMs**The equilibrium fee charged by each bank Since each bank serves consumers, the profit levels are given by Industry profit is given by**Incompatible ATMs**• Proposition 8.1 Each bank increases its fee when it increase the number of installed ATMs relative to the competing bank.**Compatible ATMs**All customers of all banks are served by all ATMs All ATMs are available to all consumers regardless of which bank maintains their account, undercutting is independent of the number of ATMs installed by each bank The aggregate industry profit equals to**One-way Compatible**Suppose now that bank A males its ATMs available to all customers including the customers of bank B; however bank B installs incompatible ATMs so that only the customers of bank B can access its ATMs. Bank A attempts to undercut the fee set by bank B and attract B’s customers it must set its undercutting fee to Bank B attempts to undercut the fee set by bank A and attract B’s customers it must set its undercutting fee to**One-way Compatible**The profit levels are The industry profit under one-way compatibility is**Banks competition with ATMs**• Proposition 8.2 The profile level of a bank declines when it makes its ATMs available for the customers of a competing bank.**Media of Exchange as Networks- Money and network effects**• Proposition 8.3 • Suppose that there is no money in this economy any meeting between any two people will result in no trade. • A barter economy cannot achieve a Pareto-optimal allocation Pure exchange economy：the effect of fiat money**$**Alice Likes apples Has bananas Benjamin Likes bananas Has carrots bananas apples Carrots $ Charlie Likes carrots Has apples $ Media of Exchange as Networks- Money and network effects • Proposition 8.4 • An introduction of fiat money into an economy supports trades that result in a Pareto-optimal allocation. Pure exchange economy：the effect of fiat money**Money and network effects**• Proposition 8.5 It is sufficient that a relatively small number of individuals refuse to trade with money for having all individuals in the economy refusing to accept money in return for goods. • Proposition 8.6 even in states of public panic concerning the loss of value of the currency, currency could still serve as the main medium of exchange as long as governments accept tax payments and play salaries using currency notes.**Media of Exchange as Networks- Coexistence of different**payment instruments • Two types of interacting agents： (1)Buyers (2)Merchants • Three means of payment： (1)electronic-cash cards (2)currency notes and coins (3)charge cards**Merchants’s Costs for each means of payment**• Assumptions on the non-fee costs merchants must bear when accepting each medium of payment • Currency： (1)Loss of time ΥM (2)0≦λM≦1 (3)per-transaction cost of ΥM +λMP • Electronic cash cards：no physical costs are associated with electronic cash card transactions • Charge cards：from a consumer is required to get an authorization that verifies that the customers has a sufficient credit to cover fro the purchase.Let φdenote the merchant’s credit verification per-transaction cost.**Buyers’ Costs for each means of payment**• Currency： (1)The value of lost time ΥB (2)Loss of money with probability λB (3)per-transaction cost of ΥB +λB P • Electronic cash card (1)Loss of the card with probability λB (2)Loss of e-cash due to magnetic errors resulting in a loss of reading capability , with probability of γB (3)per-transaction cost of (λB +γB) P • Charge cards：assume that charge cards do not impose any physical costs**Equilibrium determination of payment media**• Proposition 8.7 • Let ΥB /γB<(φ-ΥM)/M，three payment will coexist • Small transactions will be paid for with electronic cash cards medium-sized transactions with currency notes and coins large transaction with charge cards. • A reduction in the probability of magnetic errors, γB,in • electronic cash cards,or a reduction in merchants’ credit • verification cost, φ,can bring into the elimination of currency • as a means of payment. • As soon as confidence is built around these cards,buyers will substitute electronic cash cards for notes and coins,which are extremely hard to handle.