Why do we tip?

You’re in a restaurant with friends, you’ve just finished your meal, it was ok, nothing spectacular, but when it comes to pay for the bill, for some reason you pay more than it cost. Why did you do this?

For economists, tipping is an odd thing. It is often assumed that people are rational and that they will try to maximise their happiness given their limited budget. But for someone to choose to give away some of that budget unnecessarily is a confusing issue indeed.

Consumer Surplus

Whenever anybody buys something they do so because it adds more value than its price. For example if I buy an apple for 25p, I do so because I was prepared to pay up to 50p. The benefit of the apple to me is 50p. In other words I have converted 25p of currency into 50p worth of appley delight. The 25p worth of additional benefit is known in economics as Consumer Surplus.

But you wouldn’t give away Consumer Surplus to the seller of the apple voluntarily, so why do you do it in a restaurant? To answer this we need to turn to a field of economics called Institutions Economics

Institutions

Institution is a word often floated about the press but its meaning is often misunderstood. An institution is a socially accepted normal behaviour.

The Royal Family is an institution, a hand shake, a tie, queuing, a wedding and saying ‘hello’ when you greet someone are all institutions.  It is the things you do to demonstrate that you are normal person and that your behaviour is predictable.

Without institutions humans would be no different from animals, our behaviour would be erratic and civilised society would not exist.

If you think about it, shaking someone’s hand when you meet them is an odd thing indeed. We do it to demonstrate to the person you are meeting that our behaviour is predictable, that we will obey the socially accepted normal behaviour and in doing so reduce uncertainty or increase trust. If you meet someone who did not shake your hand and just stood there, you might feel uneasy and a bit awkward.

Tipping is no different, by tipping in a restaurant with you friends or girlfriend; you are demonstrating that your behaviour is normal, that you are not ‘tight’.  See the extract from Reservoir Dogs for a convincing argument.

http://www.youtube.com/watch?v=Z-qV9wVGb38

Misallocation

Tipping does cause theoretical problems however. Tipping, particularly in the US where the institution is strongest, can cause a glut in supply or a shortage in demand. If the institution is a 10% tip of the cost of the bill then price is effectively 10% higher, this means reduced demand for and increase in the amount of people who want to become a waiter (since the tip goes exclusively to the waiter). Normally the market would correct for this by reducing the wage of the waiters, but if there is a minimum wage preventing this correction then we are left with people who want to be waiters but are unable to find a job.

The people who want to be waiters are usually young, unskilled and inexperienced. Waiting is often their chance at finding employment and gaining experience for a chance at future higher paid job.

So when you tip you are upholding an unnecessary institution, you are benefiting the waiter by reducing your own consumer surplus. But you are also indirectly hurting potential waiters by reducing their employment chances.

So next time when it comes to paying your bill, perhaps you should take a page out of Mr Pink’s book and not give one just because society tells you to.