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BUS 005: Quantitative Research
Methods for Business
Lecture 3: The random variable
and discrete probability
distributions
Sanghamitra Bandyopadhyay
School of Business and
Management
1. Displaying graphs
Describe
the data
3. Probability
4. Sampling
5. Confidence intervals
Inference
7. Modelling
Quantitative Research Methods
2. Descriptive statistics
6. Test of hypothesis
Random Variables: used to describe the
outcomes of an experiment
A random variable takes a value for each possible event of an
experiment.
it is random indicating the uncertainty of its value, which we dont
know until the experiment has taken place.
usually represented by uppercase letters: X, Y, Z.
Example. Experiment: flip a coin {heads, tails};
random variable: X = {1, 0}. Or {head, tail}.
Example. Experiment: flip a coin, repeatedly, 10 times. The events are now
the number of heads when flipping a coin 10 times. Random variable:
X = {0,1,2,3,, 10}
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Random Variable types
Discrete random variables produce outcomes that come from a
counting process (e.g. number of classes you are taking).
Continuous random variables produce outcomes that come from
a measurement (e.g. annual salary, weight). They can take any
value in a range of values.
Analogy:
Integers are Discrete, while Real Numbers are Continuous
Discrete Random Variables
Examples
Experiment
Random
Variable
Possible
Values
Count Cars at Toll
Between 11:00 & 1:00
# Cars
Arriving
0, 1, 2, ...,
Make 100 Sales Calls # Sales 0, 1, 2, ..., 100
Inspect 70 Radios # Defective 0, 1, 2, ..., 70
Answer 33 Questions # Correct 0, 1, 2, ..., 33
Measure Time
Between Arrivals
Inter-Arrival
Time
0, 1.3, 2.78, ...
Experiment
Random
Variable
Possible
Values
Weigh 100 People Weight 45.1, 78, ...
Measure Part Life Hours 900, 875.9, ...
Amount spent on food amount 54.12, 42, ...
Continuous Random Variables
Examples
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How to describe an experiment and its possible
results?
Continuous
Probability
Distributions
Probability
Distributions
Discrete
Probability
Distributions
Describing an experiment
Probability Distributions
A probability distribution consists of the values of a random
variable and the probability associated with these values.
After both types of random variables (discrete or continuous) we
have two types of probability distributions:
Discrete Probability Distribution
Continuous Probability Distribution
Probability Notation
When we use its lower-case counterpart, we will be representing a
theoretic value of the random variable.
The probability that the random variable X will equal x is:
P(X = x) or just P(x)
i.e.:
P(Achieving a 2B) = P(X=2B) = P(2) = P(49<mark<59)
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Experiment: Toss 2 Coins. Let X = # heads.
T
T
Example 2. Discrete Random Variable
Probability Distribution
T
T
H
H
H H
Probability Distribution
X Value Probability
0 1/4 = 0.25
1 2/4 = 0.50
2 1/4 = 0.25
0 1 2 X
0.50
0.25
P
r
o
b
a
b
i
l
i
t
y
4 possible outcomes
3 possible events
Example 3. TVs per household in the US
Develop the probability distribution of a random variable defined as
the number of color televisions per household.
Number of Color Televisions Number of Households (1,000s)
0 1,218
1 32,379
2 37,961
3 19,387
4 7,714
5 2,842
Total 101,501
Source: Statistical Abstract of the United States (2005). Assume information is about
all households in the US. Nobody has more than 5 tvs
1,218 101,501 = 0.012
e.g. P(X=4) = P(4) = 0.076 = 7.6%
Probability distributions can be estimated from relative
frequencies.
Example 3. TV per household
0.1
0.2
0.3
0.4
0 1 2 3 4 5
X
P(x)
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1,218 101,501 = 0.012
e.g. P(X=4) = P(4) = 0.076 = 7.6%
Probability distributions can be estimated from relative
frequencies.
Example 3. TV per household
0.1
0.2
0.3
0.4
0 1 2 3 4 5
X
P(x)
E.g. what is the probability that there is at least one television but no
more than three in any given household? These events are mutually
exclusive:
Discrete Probability Distributions
Remember the rules of probability:
i
Population/Probability Distribution
When we calculate proportions using sample data we do not call them
probabilities but just frequencies.
Population features are described by computing parameters.
E.g. the population mean and population variance.
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Population Mean (Expected Value)
The population mean is the weighted average of all of its values. The
weights are the probabilities.
This parameter is also called the expected value of X and is
represented by E(X).
Example 3b:
How many TVs in a typical US household?
0,0,,0, 1,1,,1, 2,2,,2, 3,3,,3, 4,4,.4, 5,5,,5
1218
cases
32379
cases
37961
cases
19307
cases
7714
cases
2842
cases
) 5 ( 5 ) 4 ( 4 ) 3 ( 3 ) 2 ( 2 ) 1 ( 1 ) 0 ( 0
101501
2842
5
101501
7714
4
101501
19387
3
101501
37961
2
101501
32379
1
101501
1218
0
101501
2842 5 7714 4 19387 3 37961 2 32379 1 1218 0
101501
5 ... 5 ... 2 ... 2 1 ... 1 0 ... 0
...
1 2 4 3 2 1
P P P P P P
N
x x x x x x x
N N N
+ + + + + =
+ + + + + =
+ + + + +
=
+ + + + + + + + + + + +
=
+ + + + + + +
=

) 5 ( 5 ) 4 ( 4 ) 3 ( 3 ) 2 ( 2 ) 1 ( 1 ) 0 ( 0 P P P P P P + + + + + =
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Population Variance
The population variance is calculated similarly. It is the weighted
average of the squared deviations from the mean.
The standard deviation is the same as before:
Experiment: Toss 2 Coins. Let X = # heads.
T
T
Example 2b. Discrete Random Variable
Probability Distribution
T
T
H
H
H H
Probability Distribution
X Value Probability
0 1/4 = 0.25
1 2/4 = 0.50
2 1/4 = 0.25
0 1 2 X
0.50
0.25
P
r
o
b
a
b
i
l
i
t
y
4 possible outcomes
3 possible events
Example 2b:
Summary Measures Calculation Table
x p(x) x p(x) x
Total
E(x )
2
p(x)
(x )
2
(x )
2
p(x)
Ex p(x)
mean
variance
0
1
2
0.25
0.50
0.25
0
0.50
0.50
-1
0
1
1 1
1
0
1
0.25
0
0.25
0.50
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Laws of Expected Value
E(c) = c
The expected value of a constant (c) is just the value of the
constant.
E(X + c) = E(X) + c
E(b
.
X) = b
.
E(X)
We can pull a constant out of the expected value expression
(either as part of a sum with a random variable X or as a
coefficient of random variable X).
Example 5a
Monthly sales in a shop have a mean of 25,000 and a standard
deviation of 4,000. Variable costs represent 70% of sales; fixed
monthly costs are 6,000.
Find the mean monthly profit.
1) Describe the problem statement in algebraic terms:
profits = Sales variable costs fixed costs =
profits = Sales 0.70 Sales 6000
Profit (= Y) = 0.30(Sales) 6,000
Example 5a
E(Profit) =E[0.30
.
(Sales) 6,000]
=0.30
.
E(Sales) 6,000
=0.30
.
(25,000) 6,000 = 1,500
Thus, the mean monthly profit is 1,500
sales have a mean of 25,000 E(Sales) = 25,000
Profit = 0.30(Sales) 6,000
if: Y = b
.
X + c
then: E(Y) = b
.
E(X) + c
Note that c is a negative number.
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Laws of Variance: linear transformation
V(c) = 0
The variance of a constant (c) is zero.
V(X + c) = V(X)
V(b
.
X) = b
2 .
V(X)
Example 4b.
Find standard deviation of monthly profits
E(sales) = 25,000; standard deviation = 4,000. Profits are calculated
idem example 4a.
1) Describe the problem statement in algebraic terms:
sales have a standard deviation of 4,000
V(Sales) = 4,000
2
= 16,000,000
Remember: ; then
profits are calculated byProfit = 0.30(Sales) 6,000
) (Profits Var
Profits
= o
Example 4b
Find the standard deviation of monthly profits.
2) The variance of profit is = V(Profit)
=V[0.30(Sales) 6,000]
if Y = b
.
X + c, then V(Y) = b
2
V(X)
V(Profit) =V[0.30 . (Sales) 6,000]
=0.30
2
. V(Sales)
=0.30 . (16,000,000) = 1,440,000
Again, standard deviation is the square root of variance,
so standard deviation of Profit = (1,440,000)
1/2
= 1,200
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Example 6
Xavier and Yvette are real estate agents.
X = number of houses sold by Xavier in a month;
Y = number of houses sold by Yvette in a month;
An analysis of their past monthly performances has the following joint
probabilities (bivariate probability distribution).
Bivariate distributions
Bivariate Distributions
Up to now, we have looked at univariate distributions, i.e. probability
distributions in one variable.
As you might guess, bivariate distributions are probabilities of
combinations of two variables. They are also called joint probability
distributions.
A joint probability distribution of X and Y is a table or formula that
lists the joint probabilities for all pairs of values x and y, and is
denoted P(x,y).
P(x,y) = P(X=x and Y=y)
Discrete Bivariate Distribution
As you might expect, the requirements for a bivariate distribution are
similar to a univariate distribution, with only minor changes to the
notation:
for all pairs (x,y).
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Example 6
Xavier and Yvette are real estate agents.
X = number of houses sold by Xavier in a month;
Y = number of houses sold by Yvette in a month;
An analysis of their past monthly performances has the following joint
probabilities (bivariate probability distribution).
Bivariate distributions
Marginal Probabilities
We calculate the marginal probabilities by summing across rows and
down columns to determine the probabilities of X and Y individually:
E.g the probability that Xavier sells 1 house = P(X=1) =0.50
P(X=x)
P(Y=y)
Describing the Bivariate Distribution
We can describe the mean, variance, and standard deviation of each
variable in a bivariate distribution by working with the marginal
probabilities
x . P(x)
0 x 0.4 = 0
1 x 0.5 = 0.5
2 x 0.1 = 0.2
E(x) = 0.7
same formulae as for
univariate distributions
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Covariance
Definition. Covariance of two discrete variables :
The covariance measures the strength of the linear relationship
between two discrete random variables X and Y.
A positive covariance indicates a positive relationship.
A negative covariance indicates a negative relationship.
It depends on the values and units of measures of X and Y and it is not
constrained to be between -1 and 1.
Coefficient of Correlation (rho)
1 1 s s
Example 6b (cont)
Compute the covariance and the coefficient of correlation between the
numbers of houses sold by Xavier and Yvette.
COV(X,Y) = (0 .7)(0 .5)(.12) + (1 .7)(0 .5)(.42) + (2 .7)(0 .5)(.06) +
+ (0 .7)(1 .5)(.21) + (1 .7)(1 .5)(.06) + (2 .7)(1 .5)(.03) +
+(0 .7)(2 .5)(.07) + (1 .7)(2 .5)(.02) + (2 .7)(2 .5)(.01) = .15
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= 0.15 [(.64)(.67)] = .35
There is a weak, negative relationship between the two variables.
15 . 0 =
XY
o
Probability Distribution of the Sum of Two Variables
The bivariate distribution allows us to develop the probability
distribution of any combination of the two variables, of particular
interest is the sum of two variables (z= total houses sold).
x+y = 0
x+y = 1 x+y = 3
z =
P(z)
what is the probability that three houses are sold?
P(X+Y=3) = P(2,1) + P(1,2) = 0.02 + 0.03 = 0.05
x+y = 0
x+y = 1 x+y = 3
z =
P(z)
Probability Distribution of the Sum of Two Variables
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Likewise, we can compute the expected value, variance, and
standard deviation of X+Y in the usual way
E(X + Y) = 0(.12) + 1(.63) + 2(.19) + 3(.05) + 4(.01) = 1.2
V(X + Y) = (0 1.2)
2
(.12) + + (4 1.2)
2
(.01) = .56
75 . 56 . ) Y X ( Var
y x
= = + = o
+
z =
P(z)
A probability distribution is an equation that
1. associates a particular probability of occurrence
with each outcome in the sample space.
2. measures outcomes and assigns values of X to the
simple events.
3. assigns a value to the variability in the sample
space.
4. assigns a value to the center of the sample space.
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The covariance
1. must be between -1 and +1.
2. must be positive.
3. can be positive or negative.
4. must be less than +1.
Laws of expectation and variance of the sum
We can derive laws of expected value and variance for the sum of two
variables as follows
E(X + Y) = E(X) + E(Y) = 0.7 + 0.5 = 1.2
V(X + Y) = V(X) + V(Y) + 2COV(X, Y) = 0.41 + 0.45 + 2(-0.15) =
= 0.56
If X and Y are independent, COV(X, Y) = 0, then
V(X + Y) = V(X) + V(Y)
2
Y X Y X + +
= o o
Generalization: Laws of expectation and
variance of the linear combination
We can derive laws of expected value and variance for the
sum of two variables as follows
E(aX + bY) = a . E(X) + b . E(Y)
V(aX + bY) = a
2
. V(X) + b
2
. V(Y) + 2 a b COV(X, Y)
2
bY aX bY aX + +
= o o
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Portfolio Expected Return and Portfolio Risk
Two assets X and Y, with w invested in X.
Portfolio expected return (weighted average return):
Portfolio risk (weighted variability)
Where w = proportion of portfolio value in asset X
(1 - w) = proportion of portfolio value in asset Y
) Y ( E ) w 1 ( ) X ( E w E(P) + =
XY
2
Y
2 2
X
2
P
w) - 2w(1 ) w 1 ( w + + =
Portfolio Example
Investment X:
X
= 50
X
= 43.30
Investment Y:
Y
= 95
Y
= 193.21

XY
= 8250
Suppose 40% of the portfolio is in Investment X and 60% is in
Investment Y:
77 (95) (0.6) (50) 0.4 E(P) = + =
133.30
)(8250) 2(0.4)(0.6 (193.71) (0.6) (43.30) (0.4)
2 2 2 2
P
=
+ + =
Probability Distributions
Continuous
Probability
Distributions
Binomial
Poisson
Probability
Distributions
Discrete
Probability
Distributions
Normal
Uniform
Exponential
Lec. 5 Lec. 6
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Mathematical Models of Probability Distributions
Continuous
Probability
Distributions
Binomial
Poisson
Probability
Distributions
Discrete
Probability
Distributions
Normal
Uniform
Exponential
Lec. 5 Lec. 6
Binomial Distribution Properties
1. Two different sampling methods
Infinite population without replacement
Finite population with replacement
2. Sequence of n identical trials
3. Each trial has 2 outcomes
Success (any of the two) or Failure
4. Constant trial probability of success = . P(failure)=1-
5. Trials are independent: the outcome of one trial does not affect
the outcomes of any other trials.
The binomial distribution is the probability distribution that results
from doing a binomial experiment. Binomial experiments have
the following properties:
Binomial: Possible Applications
A manufacturing plant labels items as either
defective or acceptable
A firm bidding for contracts will either get a contract
or not
A marketing research firm receives survey responses
of yes I will buy or no I will not
New job applicants either accept the offer or reject it
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Binomial Random Variable
The binomial random variable counts the number of successes (X) in n
trials of the binomial experiment. It can take on values from 0, 1, 2, ,
n. Thus, its a discrete random variable.
To calculate the probability associated with each value we use this
formulae:
for x = 0, 1, 2, , n
n! = 1 x 2 x 3 x x n
Example: Don Qi
Find out:
1. The probability that Don gets no answers correct.
2. The probability that Don gets at least two answers correct.
3. The probability that Don fails the quiz, which demands a minimum
of 5 answers correct.
Don Qi exam strategy is to rely on luck for the next quiz. The quiz
consists of 10 multiple-choice questions. Each question has five
possible answers, only one of which is correct. Don plans to merely
guess the answer to each question.
Algebraically then: n=10, and P(success) = 1/5 = 0.20
Is this a binomial experiment? Check the conditions:
There is a fixed finite number of trials (n=10).
An answer can be either correct or incorrect.
The probability of a correct answer (P(success)=.20) does
not change from question to question.
Each answer is independent of the others.
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n=10, and P(success) = .20
i.e. # success, x, = 0; hence we want to know P(x=0)
Don has about an 11% chance of getting no answers correct
using the guessing strategy.
1. Probability that Don gets no answers correct?
=BINOM(0, 10, 0.20, FALSE) =BINOM(X, n, P, FALSE)
In Excel
BINOM(10, 0.20, 0, FALSE) BINOM(X, n, P, FALSE)
# successes
# trials
P(success)
cumulative
(i.e. P(Xx)?)
True = cumulative
False=probability
distribution
n=10, and P(success) = .20
i.e. # success, x, 2; that is: P(x 2) = 1 - P(0) - P(1) = 0.5906
or: P(x 2) = 1 - P(x 1 ) = 1 BINOM(1, 10, 0.20, TRUE)
2. What is the probability that Don gets at least 2 answers
correct?
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Cumulative Probability
This requires a cumulative probability, that is,
P(X at most 4) = P(X 4) = F(4) =
= P(0) + P(1) + P(2) + P(3) + P(4)
3. Probability that Don fails the quiz: x
min
= 5
We already know P(0) = .1074. Using the binomial formula to
calculate: P(1) = .2684 , P(2) = .3020, P(3) = .2013, and P(4) = .0881
P(X 4) = .1074 + .2684 + + .0881 = .9672
Thus, its about 97% probable that Don will fail the test using the luck
strategy and guessing at answers
Dons Density function
Probability
0 1 2 3 4 5 6 7 8 9 10
Probability Cumulative distribution function
1
1
0 1 2 3 4 5 6 7 8 9 10
Binomial cdf
The binomial cdf gives cumulative probabilities for
P(X k), but as weve seen in the last example,
P(X = k) = P(X k) P(X [k1])
Likewise, for probabilities given as P(X k), we have:
P(X k) = 1 P(X [k1])
3b. Probability that Don gets at least 5 answers correct?
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DNA fingerprinting
1985. Prof. Alec Jeffreys (Leicester) suggests a procedure to
produce DNA individuals pictures which may be compared across
individuals. Only twins may have similar profiles.
Fingerprints are now being used in courts for forensic and paternity
tests.
Blood samples are tried with enzymes and exposed to electric field
to produce unique fragment sequences.
DNA fingerprinting
Child bands are equal to one of their parents unless
exceptional mutations with probability 1/300.
Example: # of bands = 30;
X = # of mutations. X ~ B(n=30, p=1/300)
The questions to ask are:
1. how many bands do not come from the mother?
2. How many of these are different from those of the alleged
father?
Some drawbacks
1. Its not always straight forward to identify band matches.
2. New York Times talks about gross discrepancies between different
laboratories.
DNA fingerprinting
3. What is the probability of those not coming from the alleged
father being mutations? If this probability is too low (say below 5%),
then we should reject that the alleged father is the father.
P(X2)=1-P(0)-P(1) = 0.045;
P(X 3)=0.0001.
So if there are two bands or more with no match we may reject
that the alleged father is the father.
X ~ B(n=30, p=1/300)
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Mathematical Models of Probability Distributions
Continuous
Probability
Distributions
Binomial
Poisson
Probability
Distributions
Discrete
Probability
Distributions
Normal
Uniform
Exponential
Poisson Distribution
1. Number of events that occur in an interval (or area of
opportunity)
events per unit
Time, Length, Area, Space
2. Examples
Number of customers arriving in 20 minutes
Number of strikes per year in the U.S.
Number of defects per lot (group) of DVDs
Number of exits per mile in a motorway.
Note: the difference with binomial is that now X is not defined as successes in
a number n of trials, but in an area of opportunity.
Poisson Process
1. Constant event probability
Average of 60/hr is
1/min for 60 1-minute
intervals
2. One event per interval
Dont arrive together
3. Independent events
Arrival of 1 person does
not affect anothers
arrival
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Poisson Distribution
The Poisson random variable is the number of successes that occur in
a period of time or an interval of space in a Poisson experiment.
E.g. On average, 96 trucks arrive at a border crossing
every hour.
E.g. The number of typographic errors in a new textbook edition
averages 1.5 per 100 pages.
successes
time period
successes (?!) interval
Poisson Distribution Example
Customers arrive at a rate of
72 per hour. What is the
probability of 4 customers
arriving in 3 minutes?
1995 Corel Corp.
Poisson Distribution Solution
72 Per Hr. = 1.2 Per Min. = 3.6 Per 3 Min. Interval
( )
-
4
-3.6
( )
!
3.6
(4) .1912
4!
x
e
p x
x
e
p

=
= =
First, lambda and x must be defined for the same time period.
x is defined per 3 minutes.
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Using Excel For The Poisson Distribution
How to calculate the probability of at most 4 events
in a period of time?
POISSON(4, 3.6, FALSE) POISSON(X, , FALSE)
# successes
Mean/Expected
number of events
cumulative
(i.e. P(Xx)?)
True = cumulative
False=probability
distribution
Recommended readings
Chapter 5. Except for section 5.6.
Berenson, Levine, Krehbiel or the Pearson custom textbook