Which Inequality? The Inequality of Endowments Versus the Inequality of Rewards∗

Society often allocates valuable resources such as prestigious positions, salaries, or marriage partners via tournament-like institutions. In such situations, inequality affects incentives to compete and hence has a direct impact on equilibrium choices and hence material outcomes. We introduce a new distinction between inequality in initial endowments (e.g. ability, inherited wealth) and inequality of what one can obtain as rewards (e.g. prestigious positions, money). We show that these two types of inequality have opposing effects on equilibrium behavior and wellbeing. Greater inequality of rewards tends to harm most people — both the middle class and the poor — who increase their effort. In contrast, greater inequality of endowments can benefit the middle class. Thus, which type of inequality is considered hugely affects the correctness of our intuitions about the implications of inequality.