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    COURSE GUIDEBOOK COURSE GUIDEBOOK Business Statistics Professor George T. Geis University of California at Los Angeles Part I Business Statistics Part Lecture 1: Overview of Probability and Statisties Lecture 2: Descriptive Statistics Lecture 3: Probability Concepts Lecture & rent Probabilities Lecture 5: § Lecture 6: Random Variables Lecture 7: The Binomial and Poisson Distributions Lecture 8: The Normal Distribution S195) “J, 81095 s0ssagory [38q ‘sonspeag ssaursng 1-800-TEACH-12 1-800-832-2412 Tiae TracwiG Connany 545 www TEACH 12.com Table of Contents Business Statistics Part | Professor Blography Purpose of Course Lecture One: Overview of Probability and Statistics Lecture Twos Descriptive Statistics Lecture Three: Probability Concepts Lecture Four: Combining Event Probables Lecture Five: Simulating Business Situations Lecture Six: Random Variables Lecture Seven: The Binomial and Poisson Distribution Lecture Kight: The Normal Distribution Answers Bibliography (01997 The Teaching Company Limited Partnersip 10 7 a 7 35 » a3 82 George T. Geis, Ph.D. Anderson Graduate School of Management University of California at Los Angeles George T. Geis was born in Chicago, Illinois, in 1944, He received a B.S. “summa cum laude” with “Honors in Mathematics" from Purdue University in 1966. Dr. Geis earned his Ph.D. in 1977 at the University of Southern California and his MBA from University of California, Los Angeles in 1981. Dr. Geis was @ National Science Foundation and Woodrow Wilson Honorary Fellow. In the field of Finance, he has been honored with the Financial Executives Institute Award for outstanding achievement, During his teaching carcer as an Adjunct Professor atthe Anderson Graduate ‘School of Management at UCLA, Professor Geis has been voted outstanding teacher three times. His academic experiences include serving as Research Coordinator atthe Center for Human Resource Management. Presently, he is serving as a member of the faculty advisory board for the Entrepreneurial Studies program at UCLA. Geis is also an author. He has published dozens of professional articles and five books. His books include Desktop Computing and the Essence of Management (Prentice Hall, 1990) and Micromanaging (Prentice Hall, 1987), Currently, he is the application of computer technology to visually represent dynamics in converging technology and communication markets and the use of interactive media in illustrating statistieal analysis, He has extensive consulting experience and is a frequent lecturer on emerging tends in the computer, communications, and media markets. In his spare time Professor Geis plays three-on-three basketball, struggles to lower his golf handicap, and paints his seven-color Victorian-style home in Pasadena, California. 2 (©1097 the Teaching Company Limited Parmership. Business Statistics Purpose of the Course In our tightly wired world, business executives make decisions under pressure. Almost always, these decisions must be made with less than complete information. This course is about how to effectively use data that is currently available (or can be obtained within a reasonable time frame and cost) to improve business decision-making. We will use business examples from functional areas such as finance, marketing, human resources, and operations to ilustrate the role of data analysis in decision making. This course is not designed to be a dry sleepy-time set of abstract, ‘mathematical lectures. My goal is to make statistics come alive inthe context of life and in the context of real business problems demanding solution. ‘Quantitative methods such as statistical analysis must not be viewed as the be-all and end-all of decision making. The vial role that seasoned business intuition plays in effective decision making can not be overemphasized. Nevertheless, analytical techniques are a central part of many decisions. In fact, we illustrate in this course how statisties and probability can effectively work together with ‘managerial intuition in business problem solving. ‘The advent of personal computer statistical software that readily generates visual representations of data and performs sophisticated analyses enables a manager to ‘concentrate on the meaning of data. The burden of computation has largely been eliminated, and business people are now free to focus on probing issues and searching for creative solutions. In this course, we illustrate the use of computer- {generated output that promotes visualization of data ‘Students tell me that statistics was obscure and inaccessible for them as undergraduates, On the first day of class, they enter my MBA course on Statistics and Data Analysis prepared for the worst, Fortunately, Iam often able to help them build intuition for statistics, appreciate how the content can be applied and actually enjoy the experience. Whatever, previous experience you have had with statistics (if any), our main ‘objective will be to make the content useful to you in business decision-making aand relevant to decisions we all make in everyday life. ****In addition to questions at the end of each lecture, problems have been provided where relevant. For you convenience answers are available at the end of this outline. Statistical Software Credits For further information on Crystal Ball Software please contact Decisioneering Ine. 1,800, 289. 2550 1.308.337.3560 (F) IMP-IN 3 for Windows © is available from Duxbury Press, ‘An International Thompson Publishing Company Belmont, CA 1-800-876-2350 Images Copyrighted New Visions Technologies Inc. Al rights reserved. No part of this book may be reproduced in any manner ‘whatsoever without written permission except in the case of brief quotations ‘embodied in critical articles and reviews. For information, send complete description of intended use to The Teaching Company/Rights and Permissions, 7405 Alban Station Ct. Suite B-215, Springfield, VA 22150, USA 4 (©1997 The Teaching Company Limited Parmership Lecture One Overview of Probability and Stati ics Scope: Professor Geis explains how skill in obtaining and analyzing data can provide a business leader with significant competitive advantage. Effective decision-making is not over quantified but takes into account experience and intuition as factors. Decisions must almost always be ‘made with less than complete data. Therefore one must make decisions ‘based on inferences from the data one does have. Statistics help in developing a model for refining business decisions. Professor Geis compares and contrasts statistics with probability. He also details and illustrates the major activities of statistical analysis. Outline Statistics can provide a substantial business advantage. ‘A. Statistical analysis refines decision-making and choices in business. ‘Meaningful information gives a business a distinct advantage in a competitive world. Rapid decisions must almost always be made with Jess than complete data. Therefore one must make decisions based on inferences from the data one does have. B. Statistics helps in effectively analyzing data as well asin developing a ‘model for refining business decisions. We build models to simplify ‘complex business situations. Effective decision-making is not over- ‘quantified but takes into account experience and intuition as facto, Statistics takes inert data and brings it to life. |A. Statistics involves collecting, analyzing, and understanding data for effective decision-making. Statistics make sense ofthe big picture. The key characteristics of the data provide insight into the problem under consideration, Good statistical analysis pays attention to the outlier. An outlier isa data point that falls away from most ofthe others. The outlier(s) may be ‘included, excommunicated, or accommodated. An outlier may indicate thatthe model is not adequate or expansive enough. On the other band, the outlier may be so unusual that it really does not belong in our data C. Business statistics may utilize a variety of data sets. Some examples of data sets from the business world include: financial, marketing, attendance patterns, production quality, human resources, Data analysis cculs across all the functional areas of business. er tee teehee apes tM : IIL. The core activities of statistics concern themselves with data collection, representation and usage. ‘A. It is necessary to design a plan for data collection. Data may be acquired from another source, known as downloading, Data may also be developed by gathering information, B. The aim of descriptive statistics isto represent the data or results of research in tabular, graphical, or numerical form, The data must be summarized in some way in order to describe and visualize it, The key characteristics ofa set of data emerge and provide a picture of the situation. C. Inferential statistics refers to a group of methods used to draw inferences about a population from data available on a sample of the population. Inferential statistics moves from a sample group analysis to {draw conclusions about a parameter inthe population at large. ). Hypothesis testing seeks to determine which of two competing ideas is correct. It addresses a problem by testing an expected solution to the problem. An example of hypothesis testing in the business world might be: Is the current production quality under control or out of control? E. A forecasting model predicts what is likely to oceur in a future situation based on a number of different factors. For example, statistics ean be used to predict what the sales per square foot will be in a new restaurant based on location, demographies, and other factors. IV. Probability is a number expressing the likelihood that a specific event will occur, expressed as the ratio of the number of actual occurrences to the ‘umber of possible occurrences. A. Probability is used to predict a future outcome. Based on assumptions about how the world works, probability quantifies the likelihood of a future outcome. B. We can view probability asthe “inverse” of statisies. Statistics begins ‘with what is observable and draws conclusions about how the world ‘works. Probability starts with a view of how the world works and tries to forecast what will occur. \V. Classifying data sets makes the information they contain more useful 6 ‘A. Data sets consist of measurements For individual records called clementary units. Example: salaries for individual employees. B, Data sets may be classified according to the number of variables for each elementary unit as univariate, bivariate, or multivariate. Univariate data sets concern themselves with one measured variable. Bivariate data sets contain two measurements for each elementary unit. Multivariate data sets contain three or more measurements for the data set. 01997 The Teaching wnpany Limited Partestip C. Data sets can be classified by whether or not time sequence is important, 1. Time is important in time series data sets since time is one of the dimensions. The daily Dow Jones Average is an example of ime series data ‘Time sequence is not considered in cross-sectional data. The data is ‘only meaningful for one slice of time. One example might be the college ranking of basketball teams. A measurement is given for ‘each of the elementary units for a particular slice of time. D. Data sets can be classified by the kind of measurements recorded for ceach unit. 1. Quantitative data can either be discrete or continuous. a, Discrete data ean be counted. For example, How many times did you drink coffee today? b. Continuous data is any variable that cannot be listed as a discreet number. Time and distance are common examples of ‘continuous data, 2. Qualitative data is classified as ordinal or nominal 8. Ordinal data uses a scale to rank or order objects or persons on ‘a continuum. This provides information about the rank order (on a particular variable. These numbers have meaning in the ranking but they are not generally added or subtracted. . Nominal data uses numbers to stand for names or categories representing the way objects or persons differ. Common, ‘examples of nominal data include sex (male or female), ace, tc. There is no implied ranking. Refer to Dodger Data Set Category ‘Type of data Games attended quantitative, disereet Age quantitative, discreet Firsteage quantitative, discreet Race qualitative, nominal Distance ‘quantitative, continuous Sex qualitative, nominal Refer to Dodger Attendance Histogram The histogram is a useful way of visualizing the data, This histogram helps portray the fact that there are two different groups of fans: the regular fans and the season holder or “super” fan Slicing the Dodger Data Set Games Age First-age Race 1 18 6 c 5 32 12 H 3 4% 2 oC 4 477 c 35 42 7 H Distance Sex 10 M 5 M 20 M 25 F 30 M Dodger Attendance Histogram Games/Season O2ecen Nw om a oo ee eo (©1997 The Teaching Company Limited Partnership Frequency Questions for Lecture One 1, True or False: A model is essentially a reduction technique for making. sense out of one’s world, 2. Define statistics. 3. Whatis an outlier? 4. Statistics cuts across all functional areas of business. Explain. 8. Distinguish between inferential and descriptive statistics 6. In what sense is probability the “inverse” of statistics? 7. You are developing a data set that provides prices of an IPO (Initial Public Offering) at issue, one month after issue, and six months after issue. Is this data set univariate, bivariate, or multivariate? 8. Is addata set that provides NCAA college basketball rankings as of 1/15/97 time series or cross sectional? 9. An investment bank ranks stocks I, 2, or 3 (I being most timely for investment, 3 being least timely). Should this data be thought of as nominal, ordinal or quantitative? Essential Reading for Lecture One Aczel, Complete Business Statistics, Chapter 1, Irwin, Third Edition, 1996. Recommended Reading for Lecture One 2 Probability as a Basis for Action,” American Statistician, Vol. 29, 1975, 146-152. Hanke and Reitsch, Understanding Business Statistics, Chapter 1, Irwin, 1994. Demin (©1997 The Teaching Company Lime # ass Lecture Two Descriptive Statistics Scope: In this lecture we discuss the purpose of descriptive statistics, What are some important ways to view and summarize data? Why is variability so important in analyzing a business situation? Outline 1. Descriptive statistics portrays and summarizes a set of data so that its key characteristics become evident. Raw data is transformed into useful, refined information. TL. Various graphing techniques have been developed for viewing and summarizing data ‘A. Bar charts and histograms use the area of rectangles or bars to portray differences and trends in data. Bar charts usually portray the measure of frequency of a qualitative variable, Histograms visualize how a quantitative variable is distributed 1, ‘The bar chart below answers the question, How may films a year do each of the film companies produce? bar chart #films cc 20 18 28 ist 12 10 5 ° MGM Fox Disney 0 (©1097 The Teaching Company Limited Parmer 2, This histogram starts with the quantitative variable, in this case, salary levels. It visualizes how the salary levels are distributed and the likelihood of being in a certain category. Histogram 30% 25% 20% 19% 0% &% $80,000 $100,000 $120,000 Likelihood of salary levels B. Contingency tables use the cross tabulation of occurrences in two «dimensions to display key characteristics, Ben Pranklin had as a goal perfection in thirteen identified virtues. He kept a record of his violations of these virtues with a eross tabulation of the virtue and day of the week, vintuE [Su [M__[T |W [th |r _|Sa 1 _[ Temper-ance W 7 Zi 2 [Silence 7 7 3 [Onder a a_i ati A A SL (©1097 The Teaching Company Limited! Parersip u A scattergram plots points in two dimensions and then tries to ft the da in some way toa line or curve. A production curve is a common application of a scattergram. An outlier is a data point that does not lie fon the curve. seattergram EPR. L o 1 2 3 4 ora D. A time series graph tracks the movement of some variable across the dimension of time. An example might be the share price of Netscape over the past year. From a time series graph we can try to visualize what triggered some of the events represented by the upturns or downturns, ‘Time series graph 18 star f}———§\\_e price 5 OE June - August IIL Statistics describes data by selecting one or more values to summarize the tire data set. Very select values try to describe the entire data set as a whole using only one or two numbers. The spread of the data set may also be visualized to provide an at-a-glance summary in a graph like a box plot or ogive. ‘A, In statistics we would like to speak with some confidence about the Population at large. It is important to understand the difference between 4 population parameter versus a sample statistic. b ©1997 The Teaching Company Limited Panes A population parameter is a numerical measure for the entire Population. An example might be the average age of all possible purchasers. The Greek letter Ht stands for the population parumeter. 2. A sample statistic is a numerical measure of a sample group. The sample is taken from the population and is an estimate of H. The symbol, X , read x-bar represents the average of the sample statistic. sample sample statistic average age of sample coup. population im Population parameter-actual average age B. When a statistic is used to estimate a parameter, it is called an estimator. ‘The sample mean, X isa statistic which is used as an estimator of the population mean, [1. The closer X is to JL the better an estimator itis For example }1 might be the average age of a customer base. X is calculated from a sample so that one can approximate with confidence the actual average age, [. C. There are several ways of measuring the central tendency of a set of data, tis useful to have one number to represent the data set. The mean, ‘median, and mode are different ways of summarizing a data set, The summary measure used effects the number chosen to represent the data, For example, use a data set with customer ages of 30, 30, 40, 50, 100 years 1, The means the arithmetic average. The ages are all added together and divided by the number of customers. 250 divided by 5 equals 50. So the mean age is 50 years. In this case the extreme value of the 100 year old customer may unduly effect the mean, The median is the central data point when in ordered from least to sreatest In this case the median age is 40 years, 3. The mode is the most common data point. In this case the mode is 30 years. There can be no mode, one mode, or multiple modes. The box plot is a useful visual data summary because it makes obvious the median, the middle fifty percent of the data, the least and greatest data points and any outliers, as well as how the data is spread out. BOXPLOT 75th * + outiter percentile Ft wNargest Ne non-outlier <— median 4 smallest an non-outlier percentile 1. The box plot conta coming out ofthe box. 2, The line in middle is the median valu 3. The op ofthe box isthe 75th percentile; the bottom is 25th percentile. The center of the data is contained within the box. J. One of the two “whiskers” extends from largest non-outiet to the box ,a line through the box, and whiskers, ‘75th percentile edge of the box. The other whisker extends from the smallest non-outlier to the 25th percentile edge of the box. 5. Any outliers are indicated by a star E. A cumilative-frequeney graph or ogive is a graph that builds up ioward the right with each increment including the data preceding it. 1. Discrete data, for example age, looks like steps in an ogive. 2, Continuous data looks more continuous. loom Cumulative-requency graph or som 4 Osive 20% o% 10 2030.40 50 60 70 80 90 100 ‘Age in years IV. Variability takes into account the differences in response. It is helpful to know how close the data set isto the mean, v. A. B. Variability has a central role of statistical analysis. ‘The traditional choice for measuring variability is the standard deviation, The standard deviation is a measure of how close each ofthe data points are on average to the mean, The standard deviation is given by the mathematical relationship below. ‘A mx. XY Most data points tend to be within two to three standard deviations of the mean. Some way-out events like a stock market crash may be twenty standard deviations from the mean. ‘There are other summary measures that are useful for describing data set, A B. Skewness measures the asymmetry oF a distribution. Therefore, ifthe data plot it tends to have a tal in which the curve goes up but is rot symmetrical. There can be right-skewed and left-skewed distribuions. ‘The bulk ofthe data is opposite the tal or skew. Kurtosis measures of peakedness of a distribution, The shape of distribution can range from very peaked to very flat. 1. Leptokurdic describes a distribution that is very peaked. In this case the data is clumped together. 2. Platykurdic describes a distribution that is very fla. In this case the data is very spread out. £01997 The Teochine Company Limited Parershio Is (Questions for Lecture Two Lecture Three 1. Describe the purpose of descriptive statistics in business. Probability Concepts 2. What does the height of each bar ina histogram represent? 3. True or False. A scatergram provides across tabulation ofthe data by ke Scope: Probability plays an important role in analyzing business situations and ‘characteristics. van ad in refining intuition. In business situations, complexity is often the norm. Therefore, in order for a model to be adequate, it must have some room for complexity and subtlety. Probability helps us move from the known to the unknown and to assess the likelihood of future evens. Distinguish between a parameter and a statistic. ‘What does the 95th percentile ina data set represent? ‘True or False. A box plot serves a similar purpose asa histogram ~ 10 Various ways of determining probability will be introduced in this provide a visual image ofthe distribution ofthe data lecture. 7. ‘True or False. The standard deviation summarizes how far from the median the data typically are? Outline eee 1. The goal of probability i to understand what is likely to happen in uncertain Problems for Lecture Two future situations within “known” systems. Good business decision making uses probability o obtain assessments of various possibilities: competitors ‘The following data represent monthly housing rents paid by employees in your centering the market, cost patterns, cash flows, etcetera. accounting department: $500, 600, 600, 600, 700, 800, 800, 900, 900, and 3,000. Answer the following questions relating to this dataset 1. Calculate the mean, mode, and median values of the data set A. Probability starts with the known and moves to the unknown, B. If. good model is developed then we have a good way to make predictions 2 Draw a histogram ofthe data ‘The difference between probability and statistics may be ilustrated as 3. _ Is the data skewed to the right or skewed tothe left? What does this follows skewness mean? 4. What is the standard deviation ofthe data sot? [What happened? > SSTATISTIOS> How the word works 5. What is the standard deviation if the highest rent (arguably an outlier) is excluded? How the world works > PROBABILITY >What will hap IL, To predict the future a model for refining intuition must be developed. The following flowchart serves this purpose. Essential Reading for Lecture Two pape Aczel, Complete Business Statistics, Chapter 1, Irwin, Third Elion 1996, Model for Refining Intuition Recommended Reading for Lecture Two TTT ct standing Business Statistics, Chapter 4, Irwin, ‘Analytical Hanke and Reitsch, Understanding Business Statistics, Chapter 4, Irwin, 1994 Velleman and Hoaglin, Applications, Basics, and Computing of Exploratory ‘Access to Data Analysis, Duxbury, 1981. Information, Raw Refined. Implemented net Intuition [—>] Intuition ‘Access to Expertise 16 (©1007 The Teaching Company Limited Partnership Cee eee eae » IIL, Experimental probabil xy provides a basis for probability judgments. The results of random experiments or customer surveys help in the decision ‘making process, Desired product features can be determined by the information obtained. ‘A. The random experiment: procedure that produces an outcome that can't be perfectly predicted. B. The sample space: a list ofall possible outcomes of the experiment. For ‘example, the sample space for flipping a coin one time is (H, T}; for rolling a die is (1, 2,3, 4, 5,6} C. The outcome: the result that occurs each time a random experiment is run, For example, the outcome of five coin flips may be heads, heads, tails, heads, tals. D. The event: a collection of outcomes specified in advance; a subset of the sample space. For example, when flipping a coin, we may be interested in the event heads. IV. Probabily related to events helps deal with complex situations. A. Probability indicates how likely itis an event isto occur by a numerical value between zero and one. This value may be expressed as a fraction, decimal or percent. A probability of zero means i isnot ever going to happen. A probability of one means the event is always going t0 happen. Even a very unlikely event might occur over a long period of time. We have to keep in mind the time horizon in calculating probability. B. The probability of an event can be expressed in terms of “the odds”. For example, in a horse race, a certain horse may have 9to | odds. The 1 probability ofthat horse winning is p=7q_ as calculated by the formula: eel P= Pst) where p=probability and P+ refers to the odds 1 1 With 1 to 1 odds p=3 ; with 310 I odds p= (01997 The Teaching Company LinitedParers! C, There are various ways of deriving probability. 1. _Ineexperimentation the relative frequency is expressed as a ratio, limes the event occurs ce #erals For example, iftwo thousand golf clubs are sampled and three are found to be defective, the probability of a defective golf club would 3 be expressed as p=3q5 = 0.0015 or less than 1%. 2. Sometimes history will not be a good predictor ofthe future since the future may deviate from the past. Probability may be estimated subjectively based on experience and intuition. The calculated relative frequency may or may not be accurate dependening on the ‘expertise of the individual 3. Counting possibilities is another way of determining probability, For example, take the chances of getting two daughters ina three- child family. Let m=son, f=daughter. Make a list all the possible outcomes: mmm, mmf, mfm, mff, fmm, ffi, fmf, fff b. Determine which outcomes correspond to a two-daughter family: mf, fim, fmf. ‘e. Express the probability asthe ratio of number of two-daughter 4. Mathematial calculation of probability lets us count withou counting. For example, if there is «60% chance of sinking afre- throw, the probability of sinking ten in a row is given by p= (0.6)!0 = 0.006. This is equivalent to 6 times in a thousand tries, 'V. We can not necessarily predict the future but probability provides a means of quantifying what is likely to happen. Questions for Lecture Three Describe the overall goal of using probability analysis in business situations ‘True or False. The sample space is a listing of al possible outcomes of a random experiment, 3. What is the difference between an event and an outcome? 4. True of False. The probability of an event, a number between -I and +1, expresses how likely itis that an event will occur. ‘You want to estimate the probability of a film doing more than $100 million atthe box office (ticket sales) and ask an industry expert for her opinion. What means of deriving probability are you using? 6. Ifyou examine a database of last year's movies to estimate the probability of the film doing $100 million in box office, what means of deriving probability are you using? Problems for Lecture Three Ifa racehorse has been given 5 to 1 odds of winning, what is the implied probability thatthe horse will win? 2. Ifyou are a 70% free throw shooter in basketball, what are the chances that you will “sink” 10 free throws in a row? 3. Say your chances of picking a “winner” stock is 50% and the chances of picking a “loser” stock is 50%. If you select four stocks, what are your chances of picking exactly three winners? Essential Reading for Lecture Three Aczel, Complete Business Statistics, Chapter 2, Irwin, Third Edition 1996. ‘Recommended Reading for Lecture Three Clemen, Making Hard Decisions, Chapter 7, PWS-Kent, 1991, Hanke and Reitsch, Understanding Business Statistics, Chapter 5, Irwin, 1994, 20 (01997 The Tesching Company Limited Paresh Lecture Four Combining Event Probabilities Scope: In this lecture we discuss how to obtain probabilities associated with ‘more complex events. We introduce the notion of simulation, how it relates to probability, and how it can be used in business decisior ‘making. Business situations are usually complex. We develop the intuition behind conditional probability, independence, and mutual exclusivity. Outli 1. Simulation provides the means for forecasting success or failure, potential revenue, of how the market may respond to a new product launch, Monte Carlo simulation is used extensively in business to deal with uncertainty. ‘There are many popular software packages available that incorporate Monte Carlo simulation inside a spreadsheet. A. There are three steps in the Monte Carlo simulation, A. Generate assumption cells 2. Given the assumed values above, calculate the value inside a spreadsheet, perhaps a hundred, or a thousand times, This develops a tracking mechanism for the range of possibilities. 3, Display the range of possibilities in a forecast chart. The forecast chart shows the range as well as the probability corresponding to each potential value, B. Refer to the revenue forecast model below. Each entry also has behind it a range of assumed values. The distribution of these values can vary. For ‘example the price assumption could be a triangular distribution ‘Competitor entry can also be an assumed value. Revenue Forecast Model evens smulon: Product La ect: NoCompettor, — 0 Pre: Conpetior 0 ‘onune No Congetior 0 Vonane We Cnet 0 Compa Et? ° Sales Pe 0 C. Refer to the Forecast Chart below. This simulates the cash flow resulting from a project launch. Simulation goes beyond stipulating the range ; it also gives the probability associated with each value in that range. Forecast Chart Forecast: 97 Revenue Fraquoncy Chart 500 Trials Show ” , | sux” sao ox se eran arg tom 34 aK TL. Venn diagrams depict probabilities spatially, ‘A. The sample space, X, is a rectangular region containing the entire range of possibilities of what could happen. x 2 (©1997 The Teaching Company Limited Partnership B. An event, A, is represented spatially by a circular area. Everything inside the circle corresponds tothe desired event. Not-A is represented by everything outside the circle. A and -A are complements x . Intersections occurs when there is an event, A, and an event, B. The two circular areas overlap. The area that they share in common represeats both events occurring, To calculate the probability of A or B occurring, do not add the probabilities together. The area in common must be subtracted or it will be counted twice. Therefore, p(A or B) = p(A) + p(B) - p(A-B) x (©1997 The Teaching Company Limited Partnership 2 D, Mutually exclusive events, A and B, share no common points. For ‘example, A could represent an earthquake occurring in the next 30 seconds. B could represent no earthquakes today. Ifevent A occurs, itis impossible for event B to occur atthe same time and vice versa. IIL. Conditional probability when you revise the probability of an event to reflect information that another event has occurred. A. Probability of A, given B is expressed as p(A(B).. B. For example, a sales price will be affected by whether or not a competitor centers the market, TV. Independent events occur when one event does not have any relationship to another. What happened in the past does not impact or change the future A. For example, the roulette wheel is not influenced by what occurred before, whereas blackjack is since the cards dealt affect what cards B. To calculate the probability of A and B, multiply. P(A and B) = p(A)p(B) C. If two events are mutually exclusive, then almost certainly they are not independent. One event docs have a relationship on the other. 'Y. Check your understanding of combining information about events with the following problem: ‘You apply for four jobs and have a 1/4 chance of getting each one. assuming independence, what are the chances of getting at least one” A. Since the events are not mutually exclusive, you might be offered more than one job, one job, or no job at all, So you cannot merely add the probabilities together or muitiply them, 2 (©1997 The Teaching Company Limited Parertip L b.wt i ty meio en Thepramnny ofotentagenhot eons S03 S42. Ehret edger erect 3 qrsinaly Soe ‘getting a job from one. 1 probability of getting atleast one job offer, or maybe more, is 68%. (Questions for Lecture Four Why ie it important in business tobe able to analyze probabilities that involve combinations of events? ‘True or False. Monte Carlo simulation is one way to effectively combine probability information about events. Define what is meant by conditional probability. Explain what i Define independent events in your own words. ‘True or False, Iftwo events are mutually exclusive, then they are independent. implied if two events are mutually exclusive. Problems for Lecture Four ‘The following problems relate to this situation. Assume you apply to three colleges and that you have a 1/3 chance of getting into each one. Assume independence. 1. Are the chance of being admitted to atleast one college 1B+1/3+1/3 = 17 Why or why not? 2. Are the chances of being admitted to at least one college 1/3 x 1/3 x 1 1/27? Why or why not? 3. What are the chances of being admitted to atleast one college? 4. What are the chances of being turned down by all colleges? Essential Reading for Lecture Four Aczel, Complete Business Statistics, Chapter 2, Irwin, Third Edition 1996, Recommended Reading for Lecture Four Clemen, Making Hard Decisions, Chapter 7, PWS-Kent, 1991. Hanke and Reitsch, Understanding Business Statistics, Chapter 5, Irwin, 1994, 26 (©1997 The Teaching Company Limited Parmership Lecture Five Simulating Business Situations Scope: In this lecture we show how simulation builds on our understanding of probability. We review the steps in setting up a Monte Carlo simulation Understanding how probabilities work and distributions are built is an essential clement to building a good simulation model. The model is good to the extent that it approximates the reality of the business situation that it represents. Since it isa reduetion tool, no model is perfect, but it helps us to deal with uncestainties in trying to predict the future, Simulation models help us deal with risks and make a decision using analytical as well as intuitive power. Outline 1. Simulation is a useful technique for modeling business situations with uncertain conditions. ‘A, Assumptions are built into each cell of the simulation model, which is usually run inside ofa spreadsheet. The probability of a given value ‘coming up will be driven by the distribution which sits behind each assumption. BB. Historical information along with other factors is used to obtain the probability estimates for the distributions. TI, Monte Carlo simulation was developed in the 1940's by John Von "Neumann who used it in physics. Now Monte Carlo simulation has many other applications, including business, Random numbers are selected for cach assumption cell drawn from the related distribution, ‘A. The steps involved in Monte Carlo simulation 1.Generating random numbers to conform model assumptions 2.Caleulating one iteration (recalculation of the model) of the event ‘3.Displaying simulation results in a forecast chart B. Monte Carlo simulation is not the only technique for modeling. TIL. Simulation is useful in business decision as a product can have many lives ‘on paper before final decisions are made. Business people often think in terms of a triangular distribution: worst case, most likely and best case scenarios. These distributions can be randomly entered in a simulation ‘model. The result is not only the range of likely possibilities but also their probabilities IV. Forecasting revenue for a product launch is a type of business situation that can be simulated. Refer to the chart below. (©1997 The Teaching Company Limiod Parmer 2 VL A One Iteration of the Model Revenue simulation: Product Launch 1997 Price: No Competitor eee Td Price: Competitor 87 Volume No Competitor sis Volume With Competicor asp Competitor Entry? i Sales Price $97 Sales Volume 3572 Sales Revenue $200833 ch of the first five shaded areas is an assumption cell used to forecast the projected sales revenue, also shaded in. In this example different kinds of distributions are built into the assumption cells. 1 The competitor entry cells are a discreet distribution 2.The price entry cells area triangular distribution, A triangular

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