A Comparison-Contrast of Adam Smith, JM Keynes and Jeremy Bentham on Probability, Risk, Uncertainty, Optimism-Pessimism and Decision Making with Applications Concerning Banking, Insurance and Speculation

International Journal of Applied Economics and Econometrics,Volume 19, No.4,October -December 2011,pp. 86-111.

20 Pages Posted: 19 Dec 2010 Last revised: 1 May 2012

Michael Emmett Brady

California State University - Department of Operations Management

Date Written: December 18, 2010

Abstract

Both Smith and Keynes have very similar conceptual approaches to what probability is, how it is used and applied and the areas of application in which it can aid a decision maker. They both accept an interval approach to probability based on inequalities and bounds versus ordinal, subjectivist Bayesian and relative frequency approaches. This led them to have very similar views with respect to analyzing speculative bubbles, lenders versus borrowers risk assessments, the dangers of speculative financeespecially if the bankers themselves are or become speculators and/or are financing speculators, and a policy of maintaining low, fixed rates of interest in order to control the speculative demand for money.

Both Keynes and Smith showed how their very similar constructs led to the creation of a viable insurance industry that would be based on an inexact approach to probability.

Bentham’s views on probability and decision making are directly opposed to those of Smith and Keynes. Bentham can be regarded as the founder of the subjectivist, Bayesian approach to decision making. The modern Subjective Expected Utility (SEU) approach can be traced back to Bentham’s original arguments about the ability of rational decision makers to calculate using precise numerical probabilities and outcomes. Bentham is the first, major proponent of the exact approach to probability and decision making.

Smith and Keynes would reject the Kahneman-Tversky behavioral economist “Heuristics and Biases“ approach that regards mathematical probability as the normative criterion that all decision makers should attempt to emulate since this approach is a more advanced mathematical version of Bentham’s original approach. Mathematical probability, which requires the use of precise or sharp numerical probabilities, can only be normative in the case where the decision maker has a complete information set and/or knows for certain that a specific probability distribution will apply now and in the future. The mathematical laws of the probability calculus only hold as a limiting case whenever humans are part of the equation. Both Keynes and Smith rely on an inexact, interval, non additive, nonlinear approach that directly conflicts with the exact, single number, additive, linear approach recommended by Tversky and Kahneman as being the hallmark of human rationality in decision making.

On the other hand, Bentham’s approach is an earlier version of the exact, linear and additive approach recommended as being rational by Tversky-Kahneman.

Smith and Keynes, however, did emphasize fields that today are called Cognitive Science and Cognitive Psychology. Here pattern recognition, similarity, induction and intuition played an important role.

Keywords: Probability, Keynes, Smith, Uncertainty, Risk, Speculation, Bentham

JEL Classification: B23, B30, B41, E12

Suggested Citation

Brady, Michael Emmett, A Comparison-Contrast of Adam Smith, JM Keynes and Jeremy Bentham on Probability, Risk, Uncertainty, Optimism-Pessimism and Decision Making with Applications Concerning Banking, Insurance and Speculation (December 18, 2010). International Journal of Applied Economics and Econometrics,Volume 19, No.4,October -December 2011,pp. 86-111.. Available at SSRN: https://ssrn.com/abstract=1728225 or http://dx.doi.org/10.2139/ssrn.1728225

Michael Emmett Brady (Contact Author)

California State University - Department of Operations Management ( email )

Carson, CA 90747
United States

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