The Economics of Design

The Ultimate Guide

6 min readApr 29, 2021

As human beings, we never have a stable preference and our choices always change according to different emotions, social and environmental influences. Because of this, as designers, we should always guide the users’ decisions via strategic choice architectures. These are known as behavioral economics.

Behavioral economics explains how factors such as emotions and society can influence a person’s decisions. When we understand these aspects, we can create designs that help users make the best decision. Psychologists Daniel Kahneman and Amos Tversky conducted a series of experiments by isolating cognitive illusions that affect judgment and human tendency to make irrational choices when faced with uncertainty.

Choices are influenced by several factors

During this series of experiments, Kahneman and Tversky found that decision-making is driven by the possible value of losses and gains rather than rational evaluations of results. Designers can use behavioral economics concepts to present the right information to engage with the users and lead them to their desired end goal.

For example, behavioral economics principles have been used by Netflix to highlight the Premium plan by default to help their users select their desired subscription plan. It's tempting for anyone who’s new to Netflix to get that plan when they see it highlighted than the others. This is also known as the Von Restorff Effect which is a popular UX principle. You can refer to the 15 User Experience principles and theories article to learn more about this effect.

Payment plans for Netflix (Source: Netflix)

When it comes to Behavioral Economics, there are mainly 3 principles that were introduced by Kahneman and Tversky. These are,

Prospect Theory
Loss Aversion
Endowment Effect

Source: Behavioral Economics by Interaction Design Foundation, The two friends who changed how we think about how we think by Cass R. Sunstein and Richard Thaler

Prospect Theory

This theory shows how people make choices by weighing the pros and cons of various options (or prospects), as well as how they predict the perceived consequences of each of these options when there is a level of risks associated.

This theory matters to a designer in 2 ways,

When it comes to deciding which items to support for design projects, we could be making poor choices based on our understanding of the risk rather than the actual risks involved.
We could influence user acceptance of a product by framing the risk involved in adoption in a way that encourages risk-seeking rather than risk avoidance.

According to studies by Kahneman and Tversky on Prospect theory, it has been found that there is a lot of deep economic theory behind this concept because as we know, human beings arent rational. Prospect Theory in general has a very complex mathematical application when it comes to design which you can understand from the journal written by Kahneman and Tversky

Prospect theory concludes that people are often avoiding risks when they should be risk-seeking and vice versa. In addition to this, poor choices might be made based on our understanding of risk rather than the actual risk. These facts are relevant because it implies that we might be selecting the wrong projects for development based on incorrect risk assessments.

Source: Prospect Theory: An Analysis of Decision under Risk by Daniel Kahneman and Amos Tversky

Loss Aversion theory

People who value the avoidance of loss over the acquisition of equal benefit are said to have this attitude. Loss aversion has significant implications for web designers in terms of how we present information on web pages and interfaces where users must make critical decisions. People’s willingness to buy anything or select an alternative is influenced by how we recommend future losses and benefits.

Psychologists and behavioral economists have discovered that people perceive loss twice as strongly as they would gain because loss is twice as traumatic for us.

Consider an example of you visiting a store to buy a new phone. If the store manager tells you that you will get a $10 discount on the purchasing price and in an alternative example if the store manager tells you that you can avoid a $10 surcharge in the same situation, how would you feel about the 2 different scenarios? These 2 situations are in fact the same but stated to you in different scenarios.

When designing your products, choosing whether to offer a discount or impose a surcharge is often a challenge that affects the user’s way of thinking. This is the concept of Loss Aversion and you must use it in a beneficial way because discounts always work better than waiving surcharges! Therefore, you have always seen promotions on discounts and offers rather than surcharge rates.

Source: Loss Aversion by Interaction Design Foundation

Endowment Effect

This effect refers to the concept where people are willing to spend more money to have what they currently have than they would if they didn’t have it. As a result, we can assign an object we are asked to give up for a larger value than an object we are asked to receive. This phenomenon is thought to be a result of the loss-aversion principle, which notes that people value losses rather than gains.

Kahneman offers 3 explanations as to why the Endowment effect exists,

It involves loss aversion: The idea that we feel the pain of loss twice as strongly as we feel pleasure at an equal gain.
It involves reference dependence: The idea that we weight a loss before a gain and weigh it more heavily than a gain.
It involves a neoclassical effect: The idea that we are indifferent to the change and expect to be compensated more highly for the effort involved.

The endowment effect is most commonly used in situations like free trial periods and money-back guarantee options for users to encourage them to get your product and use it for a long time. When you provide such situations, the user is less likely to give it up as they feel like the product belongs to them. According to the endowment effect, we value a product about twice as much when it ours than when it is not!

Source: Endowment Effect by Interaction Design Foundation

Conclusion

When we understand the economics of design, we can use them to increase product adoption and retention of use but also we must make sure that the users definitely love these products that we create. Because at the end of the day if the users don’t love our products, there won't be a market for a product to be successful! Principles such as Prospect Theory, Loss Aversion theory, and Endowment effect assist us to create the best products for the users so they can always love any products they purchase.