The Economics of Tipping

Image: Fabio Venni

Would you pay an extra 15% at your local supermarket if the till operator gave you a smile and asked how your day was going? Decades of research and observation have taught us that ‘homo-economicus’ (economic human) is a rational, utility maximising figure, so why does our self-interested agent decide to hand over his hard earned money by choice?

The most widely accepted theory behind offering a tip is the idea of social norms. These unofficial rules and guidelines can be related to the idea of economic institutions. An informal institution is an unwritten established practice, which is not enforced by law, with the intention of reducing frictions in day-to-day life.

For example, reviews on eBay gives confidence to buyers that that the sellers are trustworthy. However, offering a tip does not create the same benefit other than potentially lowering labour costs for business owners. It would be a rather shrewd move from entrepreneurs to create the social construct of tipping in order to avoid paying bar staff etc. a higher wage.

As well as this, there is an incentive for workers to work harder and receive a higher wage, rather than the fixed hourly wage offered by law. Despite this apparent incentive, a study showed that differences in customer service ratings only accounted for 1-5% of tip variations received from diners (Lynn & McCall, 2000).

Related to the idea of social norms is the ‘Keeping up with the Joneses’ effect. Suppose the following scenario: You are in a restaurant enjoying a meal with your friends and the bill arrives. You hear that the table next to you are offering a tip of 20%. Would this impact your decision making when deciding whether to or how much to offer yourselves? Now imagine the table next to you offered no tip at all.

It could be argued you may even tip even more than you would have, out of pity for your server, or less because of the reduced pressure of “looking cheap”. Either way, it seems that economics has little to do with the decision making being made here and is governed instead by a superior ‘homo psychologicus’.

A potential policy solution is to increase pay for workers receiving a low wage. This is more applicable in America, where it is estimated that 4.3 million workers depend on tips to merely scrape a living (Economic Policy Institute). Proposals to increase minimum wage in America have been lambasted by economists, arguing the economic costs such as increased unemployment and inflation far outweigh the benefits.

However, an overlooked benefit of the higher minimum wage is the reduced dependency on optional tips from strangers, adding to creating a more stable income for the poorest members of society. Despite making little economic sense, tipping is so deeply entrenched in society that little can be done to break the trend without enforcing an outright ban.


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