|The Homestead Act was introduced in 1862, and granted a quarter section(of a sq
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Question
|The Homestead Act was introduced in 1862, and granted a quarter section(of a square mile or 160 acres) of land free to any household that would farm the land. The table below reports on the income a household would receive at the end of year t from working throughout the year in the city, the corresponding number for working throughout the year on a homestead, and the market price of the quarter section at the beginning of the year. To simplify the arithmetic, assume unrealistically that the discount rate is r = 0. What are the homestead land values in years 1 through 4? What is the efficient year for the household to start homesteading? What year will the household choose to start homesteading? What is the efficiency loss from the requirement that the household start farming as soon as it acquires the homestead?Explanation / Answer
In this present case ,Urban income not relevent for the following decission making, since there is no variance in Urban income, 10 for throughout the period 1 to 5. Therefor household can start homestead based on Farming income.
a) Homestead land value in years 1 to 4 would be same value in year 5 ( ignore the time value of money, since discount rate is r=0)
b) Efficient year to start homesteading is Year 4. Since in year 4 it starts earning positive Farming income.
c) Household will choose year 5 to start homesteading since Farming income is more than Urban income in year 5.
d) Once household starts Farming, they will loose or sacrifice the Urban income. Hence efficiency loss will be the Urban income that is 10.
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