To each according to ... ? Markets, tournaments, and the matching problem with borrowing constraints

We compare the performance of markets and tournaments as allocative mechani sms in an economy with burrowing constraints. The economy consists of a con tinuum of individuals who differ in their initial wealth and ability level. These must be assigned to a continuum of investment opportunities or input s of different productivity. With perfect capital markets matching is effic ient under both mechanisms. Markets, however, generate higher aggregate con sumption because of the waste associated with the production of signals und er tournaments. When borrowing constraints are present, tournaments dominat e markets in terms of matching efficiency and, for sufficiently powerful si gnalling technologies, also in terms of aggregate consumption.