The Economics of Tipping: Tips, Profits and the Market's Demand—Supply Equilibrium

Research indicates that the size of a tip is rarely correlated with the quality of the service rendered. These findings empirically refute the widely accepted economic argument that tipping is an efficient quality-control mechanism. This study provides an alternative explanation to the existence of tipping. It develops a microeconomics tipping model and demonstrates that tips affect the firm's profitability through changes in the market's demand–supply equilibrium when consumer segments differ in their demand functions and their propensity to tip. This demand–supply framework can serve as a useful tool for managers who wish to select an appropriate tipping policy for their firms.