A Comparison-Contrast between Adam Smith and Paul Davidson on the Definition and Application of the Uncertainty Versus Risk Concept in Economics
49 Pages Posted: 20 Jan 2015
Date Written: January 20, 2015
Adam Smith was the first philosopher – economist-political theorist to give a precise definition of uncertainty and then provide his readers with a number of applications of how uncertainty impacts the real economy. Smith even used his uncertainty approach to evaluate his own endeavors. Smith had a complete understanding of the differences involved in decision making under uncertainty, as opposed to risk.
Smith explained the highly limited nature of the probability calculus in real world applications and devised an interval valued estimate approach to decision making that would be used instead of the probability calculus by a decision maker. The decision maker would concentrate on the lower bound.
Smith was an intellectual giant who was at least 150 years ahead of his time. There was no economist of Smith’s time who was even close to Smith in mastering decision making under uncertainty, as opposed to risk. This was demonstrated by Smith’s exposition of an Ellsberg Paradox type problem involving two options. The risky option was the Home or Domestic trade. The ambiguous or uncertain option was the foreign trade. Smith correctly argued that the majority of business men were uncertainty or ambiguity averse. Therefore the majority would choose the Home trade. Smith’s reference to an “Invisible Hand” is a metaphor, first pointed out by G Kennedy, to help the reader grasp Smith’s point.
Keywords: uncertainty, risk, decision making, ambiguity averse, Adam Smith, J M keynes
JEL Classification: B10, B12, B22
Suggested Citation: Suggested Citation