Fair Wage versus Tipping: A Social Welfare Analysis

A tip is a voluntary payment above the sticker price to a service provider. Tipping is inherently price discrimination as different customers pay different effective prices. In this paper, I ask, what are the welfare effects from a model with price discrimination in which consumers subsidize labor costs to one in which all consumers pay the same price but workers are paid a higher wage. Holding firm profits fixed across the two regimes and assuming consumers whose willingness to pay is higher also tip more, I find that the consumer that has the highest (lowest) willingness to pay unambiguously gains (loses) from moving to a fair wage regime. Furthermore, if the wage rate increases such that firm profits remain the same, total social surplus increases but workers are worse off relative to the tipping regime. Finally, if the two groups of consumers are sufficiently different in their willingness to pay and the wage rate increases such that the worker is indifferent, total social surplus would be higher in the tipping regime.