Restaurant tipping... it's a topic everybody has an opinion about; it's a strange cultural phenomenon in the United States; and it's one that I feel is misunderstood economically. I realize that this is a highly emotional issue, and many with disagree wholeheartedly on some of the questions surrounding tipping, I just hope to present my case from as purely an economic standpoint as possible.

What You Are Paying For
Profit margins in the restaurant industry (excluding bar sales) are generally razor thin. The price on the menu is barely enough for the restaurant owner to cover the cost of the food, rent, labor, and other overhead. Speaking of labor, most employees in restaurants make close to the legal minimum wage. Servers make well below minimum wage, $2-4 per hour, depending on the state in question; therefore, they rely on tips to make up the difference. Even then, some of that tip money goes to bussers, hosts, and other employees; if you tip on a credit or debit card, some goes to taxes (although theoretically cash tips should as well, but thats another topic entirely). In essence, the cost of your meal is split into two charges: the price on the check is the cost of the meal, and the tip is the cost of the labor.

The Free Rider Problem
Many commonly believe that severs exist to treat the customer like royalty, and anything less in unacceptable; they believe that tipping (or not) is a way to reward (or punish) a server. A common argument is that (by law) a restaurant is required to pay a sever minimum wage if they don't cover it in tips. Therefore, an angry customer can punish both the server and the restaurant management by not tipping. If this happens enough, management will simply raise menu prices in order to cover costs (remember that profit margins are already razor thin). Theoretically, it is in everyone's best interest to leave zero tip, but for everyone else to leave generous tips; a classic "tragedy of commons" is likely to ensue if enough people engage in this behavior.

Table Space is a Commodity
Tipping 18% based on the cost of the meal is standard only when you eat and promptly leave the restaurant to enjoy the night out on the town elsewhere. Legally, a restaurant can't ask you to leave once you've finished eating, but if you plan on sipping water or bottomless soft drinks for the next hour, the typical 18% tip no longer applies. Every table occupied by some people who aren't ordering food or drinks from the bar is lost business for that server. Even if the restaurant isn't completely full, the sever will lose the business to another server. In other words, if a typical meal at a restaurant takes one hour, and you spend an extra hour chatting with friends, your tip should be 36% of the total check. The fact that your sever did not serve you during the second hour doesn't matter, because you took away their opportunity to serve someone else.

What is Proper Behavior?
As discussed, tipping is merely paying the cost of labor, so giving an extra large tip can be used to reward great servers, but holding back tips for bad service can lead to negative social outcomes. A better response to poor service is to leave a standard 18% tip and speak to the restaurant manager directly about what happened; if he/she still isn't able to remedy the situation, simply don't patronize the restaurant anymore. The manager will probably appreciate filing a complaint about a server with them, so that they can directly address that person and the issue. If you spend time in a server's section without ordering, tip based on the opportunity cost, not the actual cost of your check. Obviously, this strategy takes most emotion out of a highly emotional activity, which often involves making judgments about how much someone "deserves" or is "entitled to". Sometimes less emotion is a good thing, though.