What size and resolution is your TV?
Obviously, if your TV is 720p, it doesn't matter, and it's also more difficult to tell a difference on smaller TV. Even on a bigger, 1080p TV, you might not see much of a difference.
As far as which is better, that's not a simple answer. 1080p is better than 720p. But 1080i vs 720p? It depends on the content. Fast paced action such as sports can look better on 720p over 1080i because progressive scan is better with fast moving action. That's why ESPN broadcasts in 720p instead of 1080i (obviously, 1080p is best, but no one broadcasts in 1080p yet, too much bandwidth required). But for other programming, like sitcoms and news, 1080i is better than 720p. So for video games, 720p might be better than 1080i since it's fast paced action, but will you notice a difference? Maybe if you have good eyes.
If you have a 1080p TV, the 360 can output 1080p, over HDMI at least, not sure about component. That's what mine is set to. On paper, it's the best. But if your TV is 720p, then you'll probably want your 360 at 720p. Not that you'll really notice a difference.