Output and Wages with Inequality Averse Agents

We analyze a two-task work environment with risk-neutral but inequality averse individuals. For the agent employed in task 2 effort is verifiable, while in task 1 it is not. Accordingly, agent 1 receives an incentive contract which, due to his wealth constraint, leads to a rent that the other agent resents. We show that greater inequality aversion unambiguously decreases total output and therefore average laborproductivity. More specifically, inequality aversion reduces effort, wage and payoff of agent 1. Effects on wage and effort of agent 2 depend on whether effort levels across tasks are substitutes or complements in the firms output function.