In the text we argued that temporary factor-price differentials tend to be eroded by factor mobility. This question requires you to think about this process. Consider the two markets for sheet-iron workers and steel-pipe workers in the same region. Suppose both markets are competitive. We begin in a situation in which both sheet-iron workers and steel-pipe workers earn $20 per hour. Assume that workers can switch easily between the two jobs.
a. Draw diagrams showing the supply and demand for labour in each market.
b. Now suppose there is a sharp increase in the demand for steel pipe. Explain what happens in the market for steel-pipe workers.
c. If the employment of steel-pipe workers increased in part (b), explain where the extra workers came from.
d. What effect does the event in part (b) have on the market for sheet-iron workers?
e. What is the long-run effect of the shock on the relative wages in the two types of jobs?