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Adam Smith and how choice architecture makes the invisible hand more visible

Updated: Jun 7


This article explores self-interest and the invisible hand. These concepts have been around since the 1700s -- the time of Adam Smith and his transformative book, “The Wealth of Nations.” Smith's timeless book was particularly impactful on the United States. It was published in 1776, the same year as the Declaration of Independence. [i] We dig into the nuances of self-interest. We explore Smith’s earlier work, "The Theory of Moral Sentiments" to help guide the decision framework. It has complex and dynamic implications for how the invisible hand guides modern, day-to-day decision-making. We show the processes and tools to make great decisions in the context of your self-interest. Choice architecture makes the invisible hand more visible! Definitive Choice is an easy-to-use app to help you make the best decisions.


About the author: Jeff Hulett is a career banker, data scientist, and choice architect. Jeff has held banking and consulting leadership roles at Wells Fargo, Citibank, KPMG, and IBM. Today, Jeff is an executive with the Definitive Companies. He teaches personal finance at James Madison University and provides personal finance seminars. Check out his book -- Making Choices, Making Money: Your Guide to Making Confident Financial Decisions -- at jeffhulett.com.


Table of Contents

  1. Introduction

  2. Self-interest maps all our preferences

  3. A self-interest mapping example - Billy and Connie

  4. The invisible hand optimizes our collective self-interests

  5. The golden rule and stakeholders guide the invisible hand

  6. Making the invisible hand more visible

  7. Conclusion and Notes


2. Self-interest maps all our preferences


‘Self-interest’ gets a bad rap. Self-interest is often conflated with selfishness. [ii] They are different. 17th-century French philosopher Rochefoucauld said [iii]:

“Virtues are lost in self-interest as rivers are lost in the sea.”


Daniel Klein, an economist and Adam Smith scholar from George Mason University connected Rochefoucauld's aphorism to market economics and Adam Smith's version of self-interest by saying [iv]:

"Virtue is about what it is we make of our self-interest."


Consider self-interest as an aggregation of all your preferences, regardless of motivation. As related to our virtues, most people have varied motivations. As shown in the following graphic, our self-interest motivations are a combination of selfish, selfless, or anywhere-in-between preferences. Thus, selfishness describes only a portion of one’s overall self-interest. Selfishness is usually blended with selflessness to complete our more fulsome self-interest map. Examples are provided next. In a minority of cases, individuals may have more extreme preferences than average. A persistently selfish-dominated preference map describes a person's self-interest with extreme personality conditions, like narcissism. Also, just as savings may be considered delayed consumption, selflessness may be considered delayed selfishness. [v]


How self-interest relates to selfishness and selflessness

how self-interest relates to selfishness and selflessness

Self-interest traces its roots to Adam Smith, the father of market economics. The idea is, if individual self-interest is optimized, then the aggregation of the individuals’ self-interests will benefit society in total. Individual self-interests aggregate via a dynamic and spontaneous negotiation process between market participants. This self-interest aggregation process is guided by the invisible hand.


3. A self-interest mapping example - Billy and Connie


For example, Billy-the-butcher provides meat for his customers. Connie-the-consumer buys the meat she fancies from butchers and similar meat providers.

  • But what if Connie is environmentally conscious? What if Connie has certain dietary needs for herself or her family? She wants to buy the meat for the lowest price possible (selfish) but with consideration for her family and environment (selfless). These weighted preferences may increase Connie's prices. Also, elements of the selfless and the selfish often interact. For example, Connie may wish to provide for the dietary restrictions of her family (selfless) -- while simultaneously minimizing the annoying complaints she receives when her family gets food they do not like. (selfish)

The aggregation of Connie’s preferences indicates her self-interest. Her self-interest impacts the utility she receives from the meat and how much meat she buys from Billy.

  • But what if Billy needs to provide for his family? What if Billy is part of his church and needs time away from the butcher shop to sing in the choir? Billy wants to sell his meat for as much as possible (selfish) but with consideration for his family and community (selfless). His time away from the butcher shop may decrease his total revenue. Like Connie, elements of the selfless and the selfish often interact. For example, Billy loves providing his singing talent for his church (selfless) -- while his butcher shop simultaneously benefits from his known relationship with the church. (selfish)

The aggregation of Billy’s preferences indicates his self-interests. His self-interest impacts how much meat he sells to Connie.


Connie-the-consumer's and Billy-the-butcher's preferences role up to define their individual self-interests. Their self-interests combine via a dynamic and spontaneous process. The outcome of this process is measured, in part, by the meat market prices and meat market quantities. This is the invisible hand in action – It is not necessary for Connie and Billy to have an in-depth discussion about reconciling their individual preferences along the self-interest map. Their preferences are spontaneously reconciled and revealed via their market interactions.


4. The invisible hand optimizes our collective self-interests


The mechanism by which people develop and reconcile their self-interests is the great human nature deduction made by Adam Smith. First and foremost, Smith views markets as a collection of human interests. Where individual interests may begin as more extreme, Smith describes how the invisible hand reinforces a moderating convergence of individual interests.


“We are immediately put in the mind of the light in which we will view our situation, and we begin to view ourselves in the same light; for the effect of sympathy is instantaneous. … We expect less sympathy from strangers … and always endeavor to bring down our passion to that pitch.”

- Adam Smith, from The Theory of Moral Sentiments


The moderating convergence of self-interested market interactions - or, as Smith says, "bringing down our passion to that pitch" - is a signaling mechanism. The outcome signals the equilibrium market pricing and market quantity. Also, a legal system governs their market environment by which their preferences are reconciled. An important nuance is that the legal system provides guardrails to nurture signaling, not prescriptions for how to signal. Example guardrails usually include:

a) It is illegal for Billy to sell meat that would cause Connie to get sick.

b) It is illegal for Connie to steal meat from Billy.


Think of the legal guardrails as controls for outcomes emerging from socially unacceptable neurodiversity, such as narcissism or related. Such neuro diversities push the edges of social acceptability.


Generally, free market economists suggest the optimal market value is determined when the preference-expressing invisible hand operates freely across all market participants. This suggests guardrails should be kept to an essential minimum. [vi] Over time, as the Butchers' and the Consumers’ moderating self-interests are revealed via market signaling, an optimal market price and market quantity will be found across all market participants.


To provide more context from his time, Adam Smith considered self-interest via morality and justice lenses. A foundational prequel to The Wealth Of Nations is Smith's book The Theory of Moral Sentiments. ("TOMS") His earlier book explores self-interest in terms of our relationships. Smith suggests that self-interest is defensible when consistent with the demands of prudence, justice, and benevolence. While The Wealth of Nations provides a specific case for commercial interactions, The Theory of Moral Sentiments provides the overarching humanistic framework for people's interactions, commercial or otherwise.


Smith's approach was anchored in behavioral psychology. In many ways, he was the original Behavioral Economist. For example, he deduced the asymmetric nature of how people perceive losses v. gains when determining an individual's utility. [vii] This is the foundation for the "S"-shaped utility curve specified by Kahneman and Tversky in their groundbreaking prospect theory published in 1979. Kahneman went on to win a Nobel Prize for their efforts over 200 years after Smith's time. [viii] For economists, Adam Smith is like the gift that keeps on giving.


An essential nuance about Smithian moral philosophy is that he deduced how people make decisions, the social dynamics impacting those decisions, and suggested that government should be aligned with this reality. For example, Smith was not a fan of industrial policy singling out particular industries for government assistance. He believed this was better left to the invisible hand of the market.


Smith lived and wrote during the Enlightenment. The Enlightenment era was a time of great questioning of church dogmas. This was a reaction to the church's position as a judgmental arbiter of social standards. Being true as an intellectual leader of the Enlightenment, Adam Smith does NOT advocate for what people ought to do. His hunt is to describe how people actually are. He advocates that people will get the most out of life if they are true to their self-interests as a means to enable the invisible hand. Smith demonstrates that self-interest is a naturally occurring moral, social framework of prudence, justice, and benevolence. Just like Walt Whitman's quote - "Be curious, not judgmental," Smith did not pass judgment on right or wrong, but was intensely curious about the mechanisms of our moral sentiments. Within the moral sentiment framework, Smith provided an approach for people to discover the path revealing what they ought to do, without telling them exactly what that is.


To be fair, in TOMS Smith provides plenty of 'self-help' like examples for the best approach to navigate self-interest. He certainly lets on what he would do. But the beauty of his work is the framework. His examples are more in the spirit of helping to bring the framework to life than "ought to" moralistic judgment.


5. The golden rule and stakeholders guide the invisible hand


While Smith's time period is known for the questioning of strict church dogmas, his worldview was significantly impacted by religious teachings. Moral justice tenets such as the golden rule – “Do to others as you would have them do to you” – were considered central for implementing one’s self-interest. Smith taught that people naturally desire - but do not always achieve - authenticity. Being authentic means doing well by others, but doing so by doing well by yourself. Self-interest has aspects of both inward-facing and outward-facing human behavior dynamics. These dynamics are captured in Smith's words:


"Man naturally desires, not only to be loved, but to be lovely."


As part of expressing self-interest, the empathy-encouraging golden rule is an essential guiding force in how preferences are determined within our self-interest maps. [ix] For Smith, the golden rule was implemented via interaction with an impartial spectator. The impartial spectator is like a virtual fellow human looking over each of us. Think of the impartial spectator as 1) an aggregation of all those people we wish not to disappoint and 2) those people are independent of the situation being spectated. The impartial spectator is akin to our conscience.


Smith suggests that we have a virtual conversation with our impartial spectator. We act selflessly in order to satisfy the standard we imagine is set by this impartial spectator. This impartial spectator helps us reduce the self-deception we sometimes use to justify dubious actions. As an important nuance, Smith recognizes that we have a local impartial spectator, which he called "the man in the breast." Sometimes our local impartial spectator may get deceived. A periodic reconciliation with a more universal impartial spectator is necessary to calibrate our local impartial spectator. The interesting dynamic is that while our action may be selfless, it is at least partially motivated by a selfish desire to look good in front of the impartial spectator. [x]


Impartial spectator example: When my children were young, they went to a wonderful local school called Colvin Run Elementary School. ("CRES") CRES had a motto it reinforced regularly with their young students. That motto is, "Do the right thing when nobody is looking." Think of the Smithean brilliance of this motto. CRES was actively placing the impartial spectator on the shoulder of each child. The idea was for the students to self-manage their behavior so the teachers would not have to! The motto went beyond the school, as the parents reinforced this 'good behavior' message at home. The approach worked quite well. Since student behavior was reasonably good, this provided more time for teaching and learning.


An essential aspect of the invisible hand is that it is shared between people. While we often think of Smith in the context of market and economic interactions, Smith’s work is far more fundamental to how people interact. The marketplace is but one example of how Smith applies his framework.


The application of the invisible hand between people uses a process of sympathy modulation. This means the interaction of sympathy between people is what balances people’s sentiments. Smith’s use of “sympathy” is closer to how we think of “empathy” today. Sympathy modulation goes beyond an individual view of sympathy – sympathy modulation is shared by the involved parties. The sympathy modulation approach helps individuals to form a more balanced and accurate view of their sentiments.


Sympathy modulation example: If Joan experiences the death of a special family member, she will experience the grief sentiment. Her friend, Sue, will sympathize with Joan’s loss. However, Sue cannot fully experience the loss, since it was not hers. Sue may encourage Joan to be appreciative of the wonderful aspects of her recently lost family member. Sue helps to modulate Joan’s grief. Joan helps Sue to appreciate her loss. Effectively, Sue helps bring Joan's grief down from the "High/Red" space in the diagram. All the while, Joan helps bring up Sue's lack of grief from the"Low/Green" space in the diagram. Over time, the sentiment oscillation moderates and converges on the more balanced orange line in the middle.

Sympathy Modulation Framework Adam Smith

Ultimately, it is the sympathy modulation mechanism that leads to a sentiment balance between Joan and Sue. This is Smith’s basis for the invisible hand in the marketplace. In the context of economics and the marketplace, Connie-the-consumer’s sentiment is hunger. Billy-the-butcher helps modulate Connie’s hunger by providing food. Connie helps modulate Billy’s needs by providing him payment for the food that he can then use in his life for other needs. The same sympathy modulation mechanism leading to balance in the grief sentiments between Joan and Sue leads to a balance of prices and quantity in the butcher market involving Billy and Connie.


It is important to note: The commercial and emotional sentiment environments are highly interactive. Market transactions will often have emotional judgments, in addition to a more objective impact. Sentiment-based interactions will often have objective elements, in addition to a more emotional impact. This is what makes Smith’s work so amazing – he deduced and specified the framework connecting more general, humanistic relationships to specific commercial transactions. The Theory of Moral Sentiments is where Smith builds the more general social theory of moral sentiments that enables him to deduce the specific commercial market application in The Wealth of Nations.


Self-interest describes how people weigh their individual preferences. The invisible hand is the next step that reconciles the self-interests of many people interacting in a marketplace. The weighing process is a natural sympathy-modulating byproduct of our human nature. To implement Smith's framework, it helps to consider a marketplace broadly. It could be a marketplace to trade goods, like meats. But beyond the strictly commercial, it could also be a marketplace of ideas, employment, church, aesthetics, friendships, etc. The invisible hand describes how our individual self-interests aggregate to create an optimal market outcome for all market participants.


As the name suggests, “invisibility” implies that:

  • Since we cannot see the invisible hand, we can only observe our outcomes and the outcomes of other market participants.

  • The invisible hand process is spontaneous, motivated by our preferences, and guided by regulatory guardrails.

  • The invisible hand process is dynamic. Individual self-interests are updated as the other market participants' self-interest changes are signaled.

Individually, our utility map is a complex set of self-interested preferences – some more selfish, some more selfless, and usually with a combination of both. These preferences are motivated by the essential stakeholders of our lives. Think of these stakeholders as a team of partial spectators. This means the stakeholder team is not usually impartial. Their motivations and resulting preferences may not be aligned with yours. Then, the stakeholder's self-interests are aggregated and reconciled across all market participants.


These stakeholder preference groups are classified into four broad and sometimes overlapping categories --> Self, Employer (or source of income), Family, and Community. As introduced in the previous example, Billy and Connie are motivated by a combination of these 4 stakeholder groups. Each group's preferences are located at various points on the selfish ↔ selfless continuum. The dynamic self-interested motivations of each group tug between the selfish and the selfless. The tugging of different motivations causes us to make priority trade-offs. Because differing motivations may create conflict between stakeholder groups, people find making trade-offs very difficult.

Preference Tradeoff Examples:

  • Connie loves the environment, but she also knows her family really likes more water-intensive meats, rather than lower water-using plant protein substitutes. Connie needs to find the “community for family” weighted balance. Her preferences have trade-offs.

  • Billy loves his family and wants to spend more time with them. Billy is also a provider for his family. As such, family time away from his business is time he could have used for another butcher sale that provided more income for him and his family. Billy needs to find the “family for employer” weighted balance. His preferences have trade-offs.

In the notes, we discuss Smith's Four Sources of Moral Approval. This helps connect the dots between the moral sentiments we experience with members of our community and market interactions. [xi] In general, the Four Sources of Moral Approval relate to the 4 stakeholder preference groups.


Notice the words "weighted balance." This suggests certain motivations and stakeholders are more or less important than others. Being clear about the weighting is both very important and very challenging to determine without assistance.


How the invisible hand builds from self-interests

how the invisible hand builds from self-interest

Individual preferences are weighted and aggregated to a single location somewhere on our self-interest map. Also, our preference set is dynamic. Preferences are subject to what behavioral economists call framing. [xii] People are so adaptable that our preferences are situationally dependent. This means that depending on how the situation is framed, our weighted preferences and resulting choices may oscillate to either side of the self-interest map. That is why so much money is spent on marketing! If we had a consistent self-interest-based preference set, then marketing would be a waste of money. But, clearly, given the $BILLIONS spent on marketing [xiii], our self-interests can be influenced.

Framing effects and dynamic preferences example – Let’s say Connie is on her way to get dinner for her family. Before she got in the car, she had weighed her family's taste for animal-based protein highest. On the way, Connie listens to a podcast indicating that animal meat production causes one of the highest carbon dioxide emissions on earth. That information, provided immediately before her dinner decision, frames her perspective on buying dinner. This “animal protein production is bad for the environment” narrative information anchors Connie in a different frame. The framing effect increases the weight Connie places on the "Environmental Concern" preference. As a result, she is less likely to buy animal protein for dinner. In the next graphic, moving from P1 to P2 shows the impact of the podcast framing on Connie's dynamically declining willingness to purchase animal-based protein for dinner.

Framing effects  on preferences and self-interest

6. Making the invisible hand more visible


As shown in the next graphic, our decision process is an updating cycle for determining our self-interest and making the optimal decision. Understanding your self-interest in the context of your next decision is essential. Both your interests and all market participants will be better served when you effectively apply your self-interests to make optimal decisions.

how to make the invisible hand more visible Definitive Choice
  1. The cycle begins with the existing self-interest driving one’s preferences.

  2. The weighting of these preferences defines the utility of a particular decision, like buying meat, a car, a house, etc.

  3. One's weighted utility model helps one choose between alternatives to optimize self-interest.

  4. The outcome is the negotiation and implementation of that choice.

  5. The outcome informs and may update one’s self-interest – and the cycle continues.

Self-interests and the invisible hand create a decision environment that is both complex and dynamic – as such - the best decisions require decision assistance. This is especially true because:

  1. Today’s world is overrun with uncurated data. This has the effect of creating more variability in our decision process. Accurate sympathy modulation is challenging to achieve. Without a strong decision process, we are more likely to lack conviction in our decision confidence.

  2. Our brain’s default decision process is geared toward fast, “fight or flight” decisions. This is a result of our evolutionary biology. The biological differences between the evolutionary fast decisions our brains naturally make and the more complex decisions necessary today present as brain quirks called cognitive biases. Perhaps, someday, our brains will evolve to handle more complex decisions.

(More decision challenges are explored in the article: Top 6 reasons why Personal Finance success starts with choice architecture)


It is normal to be either under or overconfident in the preferences driving our decisions. To achieve conviction in our confidence and accurate decisions, choice architecture is an essential companion. Choice architecture is decision science and behavioral science-informed tools. The choice architecture will help you curate data. Choice architecture will help you overcome your naturally occurring cognitive biases leading to not fully understanding complex and dynamic self-interests, preferences, and utility. It is suggested to use choice architecture tools for your most significant, financially impacting decisions. Using choice architecture tools for the significant subset of decisions, helps you learn how to make all your decisions optimally.


Choice Architecture makes the invisible hand more visible!

Definitive Choice is an app decision solution to help you understand your self-interests and actions on almost all life decisions. It provides a straightforward user experience. The number-crunching occurs in the background by time-tested decision science algorithms. It uses a proprietary "Decision 6(tm)" approach that organizes the preference criteria (what is important to you?) and alternatives (what are the choices?) in a series of bite-size ranking decisions. Since it is on your smartphone, you can use it while you are curating data to support the decision. It is like having a decision expert in your pocket. The results dashboard provides a rank-ordered list of recommended "best choices," tailored to your preferences.


Also, Definitive Choice comes pre-loaded with many decision templates. You will want to customize your own preferences (aka criteria) and alternatives, but the preloaded templates provide a nice starting point.


Using decision process solutions enables DECISION A-C-T:


  • Accelerated: faster, less costly decisions. It enables a nimble decision environment.

  • Confidence-inspired: process causes people to be more confident in the decision, increasing buy-in, and decision up-take.

  • Transparency-enabled: reporting, documentation, and charts to help communicate the decision.


7. Conclusion


We explored self-interest and the invisible hand. These concepts have been around since the time of Adam Smith and his world-changing book. In many ways, Adam Smith’s timely work provided the economic foundation for the United States and other Westernizing countries. We demonstrated the nuances of the invisible hand. It has complex and dynamic implications for day-to-day decision-making. We show the processes and tools to make great decisions in the context of understanding and updating your self-interest. Choice Architecture like Definitive Choice makes the invisible hand more visible!


Notes


[i] Of all the founders, Alexander Hamilton was the most influential architect of the American economy. Hamilton was the majority writer of The Federalist Papers, a series of articles helping to operationalize the new U.S. Constitution. The Federalist Papers provided a starting point for the U.S. Economy. As the first Treasury Secretary in George Washington's inaugural administration, Hamilton built the Federal economic system from scratch. Hamilton was very industrious. Starting from scratch, he quickly built the Treasury Department to thirty-nine employees. Compared to Jeferson's State Department, with only five employees. During his tenure, Hamilton architected or placed in motion the U.S. currency, trade, tariffs, taxation, and many other basics we take for granted today.


Chernow, Alexander Hamilton, 2004


Hamilton was obviously influenced by Adam Smith and The Wealth of Nations. Hamilton’s Final Version of the Report on the Subject of Manufactures was provided to the U.S. Congress in 1791. Adam Smith was directly quoted 3 times in this important report. In several other pronouncements, Hamilton either directly quotes or uses Smith-based concepts as support.


Bourne, Alexander Hamilton and Adam Smith, The Quarterly Journal of Economics, Vol. 8, No. 3 (Apr., 1894), pp. 328-344


[ii] Hall, SELF INTEREST RIGHTLY UNDERSTOOD, Adam Smith Works, 2018


[iii] Rochefoucauld, Maxims, 1665


[iv] Klein, Is It Just to Pursue Honest Income? Economic Affairs, 2019, 39(3): 400-409


[v] The self-interest map along the selfish-selfless continuum could be recast as the consumption-savings framework typically described in economics. The lifecycle framework is the standard way that economists think about the intertemporal allocation of time, effort, and money. In the self-interest map -

  • Selfishness is more like consumption - we are taking care of our self-interests today. The uncertainty of payoff is less in the present.

  • Selflessness is more like savings - we are saving our self-interests for another day. The uncertainty of payoff is greater in the future.

Example 1: A person's environmental sensitivity may be viewed as a selfless act. Like actively separating recyclable material from other trash. However, the environment is necessary to support human life in the long run. Thus, while an effective environmental action may not benefit us today (like consumption), those environmental actions will benefit us or our heirs in the long run (like savings).


Example 2: We think of our dedication to our children as one of the most selfless activities of our lives. But is it? Richard Dawkins wrote The Selfish Gene. Dawkins demonstrates how our genome has a single objective, to reproduce itself in future generations. Dawkins coined the term "survival machine" to describe the human body and brain as a vessel to deliver our genome to the next generation. As such, our devotion to our children is at the bidding of our selfish genes. Thus, our selfless behavior toward our children is a form of long-term savings, to deliver our genome to the next generation and to care for them so they may do the same. In earlier times, the uncertainty of the delivery of our genome to the next generation was managed by having big families. Today, because medicine and our legal system effectively eliminate existential uncertainty disrupting the selfish gene motivation, people (or their genes!) are more comfortable having smaller families. Our survival machine job is successfully completed when we have grandchildren.


Some economists suggest self-interest and selfishness are equivalent. I find this a too simplistic explanation. The intertemporal framework explains the difference. Just like savings is delayed consumption, selflessness is delayed selfishness. Our motivation's desire is time-based along the self-interest map.


Browning, Crossley, The Life-Cycle Model of Consumption and Saving, JOURNAL OF ECONOMIC PERSPECTIVES, VOL. 15, NO. 3, SUMMER 2001


Dawkins, The Selfish Gene, 1976


Stoic philosophy has much in common with Smith's moral philosophy. One of Smith's teachers, Francis Hutcheson, was a Stoic scholar. Marcus Aurelius was a leading Stoic living around the time of Jesus Christ. Aurelius promoted acting for common wealthfare as one of the core tenets of virtue. Aurelius recognized the dynamic, interrelated nature of selfish or selfless behavior. He considered selfless behavior as an investment in our own well being. Much the way today's savings is an investment in future consumption. Effectively- Stoic philosophy suggests the best for others will be the best for you.


Aurelius, Meditations, 180 CE


[vi] Adam Smith certainly believed in markets. He believed people were naturally drawn to markets to "truck, barter, and exchange." Smith also believed governments play an important enabling role for markets.

"Smith was a classical liberal, meaning a liberal in the original use of the word-someone who valued liberty and favored limited government. He saw a central role for government in providing national defense, a system of courts, and basic elements of infrastructure, such as roads and bridges, areas where he thought the private sector would struggle without government help."



Determining the 'essential minimum' for regulatory rules is subject to ongoing debate. Markets may be subject to market failures, especially when externalities are not properly valued. Pollution is an on-point example. Scientists have shown the earth is heating and many undesired outcomes may occur (rising oceans, melting ice caps, increase weather variability and extremity, etc.) Because the carbon emissions associated with industrial processes have traditionally had little cost to the producer, this pollution externality has been created and is now becoming highly relevant as a significant cost to the rest of the world. The negative impacts of global warming are a market failure outcome example.


Pettinger, Market Failure, EconomicsHelp, accessed 2023



[viii] Kahneman, Tversky, Prospect Theory: An Analysis Of Decision Under Risk, Econometrica, Volume 47, Number 2, 1979



In the "Theory of Moral Sentiments," Smith's aim was to describe how people make judgments. At the center of his theory was the notion of "sympathy." Today, how Smith defined "sympathy" is more in line with our modern view of "empathy" as central to the golden rule. In her book, Dr. Liu states:

"For Smith, the answer was found in one concept: sympathy. Sympathy was a capacity to feel with and feel for others; it was both the mechanism by which we try to understand our fellow human beings first by imagining ourselves in their position, seeing things from their perspective, and in turn, seeing ourselves as well as the object of our desires."


[xi] In TOMS, Smith describes the 4 sources of moral approval. These sources are appropriate for market interactions or more general life interactions. Think of these sources as the approval between agents for some interaction. This interaction could be buying a good - such as Connie-the-consumer buying meat from Billy-the-butcher - or how 1 person consoles another after a loss - such as Sue consoles Joan.


The four sources of moral approval (TOMS 326-327.16), are:

  1. Approval of the giving agent. (supply)

  2. Approval of the receiving agent. (demand)

  3. Approval of the interaction environment (These are the rules or norms governing today’s interaction environment)

  4. Approval of the unseen (long-term impact of 1, 2 & 3)

As Smith points out, the 4th source is the most challenging, as it is less salient and in the uncertain future. Smith suggests this is where most people need help.


In the case of Connie’s decision to buy dinner for her family, think of Billy’s perspective as the first source and Connie’s perspective as the 2nd source. Connie and Billy must approve the market interaction before the sale is consummated. The norms and laws, such as the law making the selling of unfit meat illegal or that the butcher shop has certain hours of operation is the 3rd source. Laws and norms are considered like an approving agent in this example.


Finally, Connie’s environmental focus is the 4th source. It is more challenging for all agents to value the environmental impact of their actions further into the future. Even though there is an obvious reduction of welfare in a future world with a poor environment, challenges such as the tragedy of the commons or the Trolley Problem impact the other agents evaluation of the 4th source.


All 4 sources of moral approval must be considered and trade-offs considered. In general, the first 3 sources have the ability to say “no” if the interaction doesn’t meet their needs. Often, the 4th source does not have as much ability to say “no.” For example, the environment will not say no to being abused, it is up to the other agents to implement the 4th source.


[xii] Editors, Framing effect, behavioraleconomics.com, accessed 2023

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