The cost to the merchants is then passed on to the customers through higher prices (which they can stand because they're earning so many rewards!). Sure, the merchants would like to get rid of fees, but that would only provide them a short-term gain. Over the long term, their prices would come down to compensate for their lower cost of goods sold.
Nope. Doesn't work that way. Don't get me wrong, I think merchant processing fees are outrageously high, and that merchants should be allowed to add a few percent for payment with credit cards, in order to encourage cash/debit card payment.
Australia limited interchange fees around 2003 (cut them in half), and as would be expected, merchants did not lower prices.
"Interchange fees are paid by the merchant, and there have been studies
done in Australia that said that consumers have not saved a penny by lowering interchange rates — that the merchants have not reduced prices at all."
