Stereotypes and Inequality: A Structure of Identity Choice ( paper in progress)

When identity is exogenous and if the ability distributions within groups are the same, then inequality of group reputations in equilibrium can only arise if there is a positive feedback between group reputation and individual human capital investment activities (Arrow, 1973; Coate and Loury, 1993). When group membership is endoge-nous, the logic of individuals ’ identity choices leads there to be a positive selection of higher ability individuals into the favored group. As a result, ability distributions within distinct groups can endogenously diverge, reinforcing incentive-feedbacks. We develop the theoretical framework that can examine the positive selection and the endogenous group formation, and examine the existence and stability of stereotyping equilibria. We show inequality deriving from stereotyping of endogenously constructed social groups is at least as great as the inequality that can emerge between exogenously given groups. Also, the model implies that the equal state is not sustainable when the society has enough fraction of members whose identity choice cost is sufficiently low