A Smart Album in iPhoto (as of version 4) is an album which is generated, and updated automatically, based on criteria set by the user. It is identical to the Smart Playlists of iTunes and the Smart Folders of Mac OS X 10.4. It appears as an icon of an album, in purple, with a black gear on it.
To create a Smart Album, the user chooses "New Smart Album..." from the File menu in iPhoto. A dialogue sheet then drops down, where the user can set different parameters or criteria to create a new Smart Album.
The complexity of a Smart Album can vary. Some Smart Albums can consist of a solitary criteria, while others can consist of an intricate web of parameters.