The Law of Unintended Consequences states that most policies are accompanied by reactions that were neither intended nor expected.  The unintended consequences are generally the result of perverse incentives.

Micro-economic analysis is the study of how people make decisions when their choices are constrained by external factors. 

The most common application of this analysis is in the study of market behaviour where people's choices between various goods and services are constrained by their own incomes and the limited availability of the things they want.  Therefore, most people will buy more of something the cheaper it is.  In markets, prices adjust so that they reflect relative scarcity and willingness-to-pay.  So a house in Knightsbridge, London costs more than an identical house in Oban, Scotland because there are more people with higher incomes willing to pay for the house in London.

These deceptively simple ideas can be used to reduce the unintended consequences from well-meaning policies.  Micro-economic analysis predicts, for example, that:

• rent control will be followed by a shortage of rental accommodation;
• the higher a minimum wage the more difficult it is likely to be for low-skilled workers to obtain jobs;
• general wage controls in the economy will encourage high-skilled workers to emigrate;
• making bankruptcy less onerous will increase people's willingness to declare themselves bankrupt;
• inward investment attracted to a particular area by specific subsidies will leave the area again when the subsidy is withdrawn unless other incentives to stay have developed.

 

The size of these effects depends on the specific conditions in the market concerned.  Economic research is able to identify the relevant conditions and estimate the size of the effect. This allows for a choice between policies that will minimise the adverse impacts.