Applied Statistics in

Business & Economics,

Vo Duc Hoang Vu
vu.vo@ueh.edu.vn
 Chapter 5
Probability
Chapter Contents

5.1 Random Experiments

5.2 Probability
5.3 Rules of Probability
5.4 Independent Events
5.5 Contingency Tables
5.6 Tree Diagrams
5.7 Bayes Theorem
5.8 Counting Rules
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 Chapter 5
Probability

Chapter Learning Objectives (LOs)

LO1: Describe the sample space of a random variable.

LO2: Distinguish among the three views of probability.
LO3: Apply the definitions and rules of probability.
LO4: Calculate odds from given probabilities.
LO5: Determine when events are independent.

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 Chapter 5
Probability

Chapter Learning Objectives (LOs)

LO6: Apply the concepts of probability to contingency tables.

LO7: Interpret a tree diagram.
LO8: Use Bayes Theorem to calculate revised probabilities.
LO9: Apply counting rules to calculate possible event arrangements.

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 Chapter 5
LO1 5.1 Random Experiments
LO1: Describe the sample space of a random experiment.
Sample Space

A random experiment is an observational process whose results

cannot be known in advance.

The set of all outcomes (S) is the sample space for the experiment.

A sample space with a countable number of outcomes is discrete.

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 Chapter 5
LO1 5.1 Random Experiments
Sample Space
For a single roll of a die, the sample space is:

When two dice are rolled, the sample space is the following
pairs:

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 Chapter 5
LO1 5.1 Random Experiments
Sample Space
If the outcome is a continuous measurement, the sample space can
be described by a rule.

For example, the sample space for the length of a randomly chosen
cell phone call would be

S = {all X such that X > 0}.

The sample space to describe a randomly chosen students GPA

would be

S = {all X such that 0.00 X 4.00}.

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 Chapter 5
LO1 5.1 Random Experiments
Events
An event is any subset of outcomes in the sample space.

A simple event or elementary event, is a single outcome.

A discrete sample space S consists of all the simple events (Ei):

S = {E1, E2, , En}.

For example, Amazons Web site for Books & Music
has seven categories that a shopper might choose:

S = {Books, DVD, VHS, Magazines, Newspapers,

Music, Textbooks}.

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 Chapter 5
LO1 5.1 Random Experiments
Events
Within this sample space, we could define compound events electronic
media as A = {Music, DVD, VHS} and print periodicals as B =
(Newspapers, Magazines}. This can be shown in a Venn diagram.

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 Chapter 5
LO2 5.2 Probability
LO2: Distinguish among the three views of probability
Definitions
The probability of an event is a number that measures the relative
likelihood that the event will occur.
The probability of event A [denoted P(A)], must lie within the interval
from 0 to 1:
0 P(A) 1

If P(A) = 0, then the If P(A) = 1, then the event

event cannot occur. is certain to occur.

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 Chapter 5
LO2 5.2 Probability
Definitions
In a discrete sample space, the probabilities of all simple events
must sum to unity:
P(S) = P(E1) + P(E2) + + P(En) = 1

For example, if on a shopping spree, the following percentages (on

the left) were recorded for the four methods of payments. We can
compute the equivalent probabilities which sum to 1.
credit card: 32% P(credit card) = .32
debit card: 15% P(debit card) = .15
Probability
cash: 35% P(cash) = .35
check: 18% P(check) = .18
Sum = 100% Sum = 1.0
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 Chapter 5
LO2 5.2 Probability
Empirical Approach
Use the empirical or relative frequency approach to assign
probabilities by counting the frequency (fi) of observed outcomes
defined on the experimental sample space.

For example, to estimate the default rate on student loans:

P(a student defaults) = f /n = number of defaults

number of loans

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 Chapter 5
LO2 5.2 Probability
Law of Large Numbers

The law of large numbers is an important probability theorem that

states that a large sample is preferred to a small one.

Flip a coin 50 times. We would expect the proportion of heads to be

near .50.

However, in a small finite sample, any ratio can be obtained (e.g.,

1/3, 7/13, 10/22, 28/50, etc.).

A large n may be needed to get close to .50.

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 Chapter 5
LO2 5.2 Probability
Classical Approach

A priori refers to the process of assigning probabilities before the

event is observed or the experiment is conducted.
a priori probabilities are based on logic, not experience.
When flipping a coin or rolling a pair of dice, we do not actually
have to perform an experiment because the nature of the process
allows us to envision the entire sample space.
Instead of performing the experiment, we can use deduction to
determine the probability of an event .
This is the classical approach to probability.

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 Chapter 5
LO2 5.2 Probability
Classical Approach
For example, the two dice experiment has 36 equally likely simple
events. The P(that the sum of the dots on the two faces equals 7) is

number of outcomes with 7 dots 6

P( A) 0.1667
number of outcomes in sample space 36

The probability is obtained

a priori using the classical
approach as shown in this
Venn diagram for 2 dice:

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 Chapter 5
LO2 5.2 Probability
Subjective Approach

A subjective probability reflects someones informed judgment

about the likelihood of an event.

Used when there is no repeatable random experiment.

For example,
- What is the probability that a new truck
product program will show a return on
investment of at least 10 percent?
- What is the probability that the price of Fords
stock will rise within the next 30 days?

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 Chapter 5
LO3 5.3 Rules of Probability
LO3: Apply the definitions and rules of probability

Complement of an Event

The complement of an event A is denoted by

A and consists of everything in the sample space S except event A.

Since A and A together

comprise the entire sample
space,
P(A) + P(A ) = 1 or
P(A ) = 1 P(A)

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 Chapter 5
LO3 5.3 Rules of Probability
Union of Two Events
(Figure 5.5)
The union of two events consists of all outcomes in the sample
space S that are contained either in event A or in event B or both
(denoted A B or A or B).

may be read as or
since one or the other
or both events may
occur.

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 Chapter 5
LO3 5.3 Rules of Probability
Intersection of Two Events
The intersection of two events A and B
(denoted by A B or A and B) is the event consisting of all
outcomes in the sample space S that are contained in both event A
and event B.

may be read as
and since both
events occur. This is
a joint probability.

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 Chapter 5
LO3 5.3 Rules of Probability
General Law of Addition
The general law of addition states that the probability of the union of
two events A and B is:

P(A B) = P(A) + P(B) P(A B)

When you add the A and B So, you have to

P(A) and P(B) subtract
together, you count P(A B) to avoid
the P(A and B) over-stating the
A B probability.
twice.

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 Chapter 5
LO3 5.3 Rules of Probability
General Law of Addition
For a standard deck of cards:

P(Q) = 4/52 (4 queens in a deck; Q = queen)

P(R) = 26/52 (26 red cards in a deck; R = red)
P(Q R) = 2/52 (2 red queens in a deck)
P(Q R) = P(Q) + P(R) P(Q R)

Q and R = 2/52 = 4/52 + 26/52 2/52

= 28/52 = .5385 or 53.85%

Q R
4/52 26/52

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 Chapter 5
LO3 5.3 Rules of Probability
Mutually Exclusive Events
Events A and B are mutually exclusive (or disjoint) if their
intersection is the null set () that contains no elements.

If A B = , then P(A B) = 0
Special Law of Addition

In the case of mutually

exclusive events, the addition
law reduces to:

P(A B) = P(A) + P(B)

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 Chapter 5
LO3 5.3 Rules of Probability
Collectively Exhaustive Events
Events are collectively exhaustive if their union is the entire sample
space S.

Two mutually exclusive, collectively exhaustive events are

dichotomous (or binary) events.
For example, a car repair is
either covered by the warranty
(A) or not (B).

Note: This concept can be

extended to more than two
No events. See the next slide
Warranty
Warranty

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 Chapter 5
LO3 5.3 Rules of Probability
Collectively Exhaustive Events
There can be more than two mutually exclusive, collectively exhaustive
events, as illustrated in Figure 5.9. For example, a Wal-Mart customer
can pay by credit card (A), debit card (B), cash (C), or
check (D).

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 Chapter 5
LO3 5.3 Rules of Probability
Conditional Probability

The probability of event A given that event B has occurred.

Denoted P(A | B).

The vertical line | is read as given.

P( A B)
P( A | B) for P(B) > 0.
P( B)

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 Chapter 5
LO3 5.3 Rules of Probability
Conditional Probability
Consider the logic of this formula by looking at the Venn diagram.

P( A B) The sample space is restricted to

P( A | B) B, an event that has occurred.
P( B)

A B is the part of B that is also

in A.

The ratio of the relative size of

A B to B is P(A | B).

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 Chapter 5
LO3 5.3 Rules of Probability
Example: High School Dropouts
Of the population aged 16 21 and not in college:

Unemployed 13.5%
High school dropouts 29.05%

Unemployed high school dropouts 5.32%

What is the conditional probability that a member of this population

is unemployed, given that the person is a high school dropout?

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 Chapter 5
LO3 5.3 Rules of Probability
Example: High School Dropouts
First define
U = the event that the person is unemployed
D = the event that the person is a high school dropout

P(U) = .1350 P(D) = .2905 P(UD) = .0532

P (U D ) .0532
P (U | D ) .1831 or 18.31%
P(D) .2 905

P(U | D) = .1831 > P(U) = .1350

Therefore, being a high school dropout is related to being

unemployed.
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 Chapter 5
LO4 5.3 Rules of Probability
LO4: Calculate odds from given probabilities

Odds of an Event

The odds in favor of event A occurring is

P ( A) P ( A)
Odds =
P ( A ') 1 P ( A )
The odds against event A occurring is

P ( A ) 1 P ( A )
Odds
P ( A) P ( A)
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 Chapter 5
LO4 5.3 Rules of Probability
Odds of an Event
If the odds against event A are quoted as b to a, then the implied
probability of event A is:

For example, if a race horse has a 4 to 1 odds against winning, the

P(win) is

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 Chapter 5
LO5 5.4 Independent Events
LO5: Determine when events are independent

Event A is independent of event B if the conditional probability

P(A | B) is the same as the marginal probability P(A).

P(U | D) = .1831 > P(U) = .1350 so U and D are not independent.

That is, they are dependent.

Another way to check for independence:

If P(A B) = P(A)P(B) then event A is independent of event B

since
P( A B) P( A) P( B )
P( A | B) P( A)
P( B) P( B)
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 Chapter 5
LO5 5.4 Independent Events
Multiplication Law for Independent Events
The` probability of n independent events occurring simultaneously is:

P(A1 A2 ... An) = P(A1) P(A2) ... P(An)

if the events are independent

To illustrate system reliability, suppose a Web site has 2

independent file servers. Each server has 99% reliability. What is
the total system reliability? Let,

F1 be the event that server 1 fails

F2 be the event that server 2 fails

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 Chapter 5
LO5 5.4 Independent Events
Multiplication Law for Independent Events

Applying the rule of independence:

P(F1 F2 ) = P(F1) P(F2) = (.01)(.01) = .0001

So, the probability that both servers are down is .0001.

The probability that one or both servers is up is:

1 - .0001 = .9999 or 99.99%

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 Chapter 5
LO6 5.5 Contingency Table
LO6: Apply the concepts of probability to contingency tables

Example: Salary Gains and MBA Tuition

Consider the following cross-tabulation (contingency) table for n =
67 top-tier MBA programs:

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 Chapter 5
LO6 5.5 Contingency Table
Example: Salary Gains and MBA Tuition

Are large salary gains more likely to accrue to graduates of high-

tuition MBA programs?

The frequencies indicate that MBA graduates

of high-tuition schools do tend to have large
salary gains.

Also, most of the top-tier schools charge high tuition.

More precise interpretations of this data can be made using the

concepts of probability.

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 Chapter 5
LO6 5.5 Contingency Table
Marginal Probabilities
The marginal probability of a single event is found by dividing a row
or column total by the total sample size.

For example, find the marginal

probability of a medium salary gain (P(S2).

P(S2) = 33/67 = .4925

Conclude that about 49% of salary gains at the top-tier schools

were between $50,000 and $100,000 (medium gain).

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 Chapter 5
LO6 5.5 Contingency Table
Marginal Probabilities

Find the marginal probability of a low tuition P(T1).

P(T1) = 16/67 = .2388

There is a 24% chance that a top-tier schools MBA tuition is under

$40.000.

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 Chapter 5
LO6 5.5 Contingency Table
Joint Probabilities
A joint probability represents the intersection of two events in a cross-
tabulation table.

Consider the joint event that the school has

low tuition and large salary gains
(denoted as P(T1 S3)).

P(T1 S3) = 1/67 = .0149

There is less than a 2% chance that a top-tier school has both low
tuition and large salary gains.

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 Chapter 5
LO6 5.5 Contingency Table
Conditional Probabilities

Find the probability that the salary gains are small (S1) given that
the MBA tuition is large (T3).

P(T3 | S1) = 5/32 = .1563

Independence

Conditional Marginal

P(S3 | T1)= 1/16 = .0625 P(S3) = 17/67 = .2537

(S3) and (T1) are dependent.

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 Chapter 5
LO6 5.5 Contingency Table
Relative Frequencies
Here are the resulting probabilities (relative frequencies). Each vale
is divided by 67. For example,
P(T1 and S1) = 5/67 P(T2 and S2) = 11/67 P(T3 and S3) = 15/67

P(S1) = 17/67 P(T2) = 19/67

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 Chapter 5
LO7 5.6 Tree Diagrams
LO7: Interpret a tree diagram
What is a Tree?
A tree diagram or decision tree helps you visualize all possible
outcomes.
Start with a contingency table.
For example, this table gives expense ratios by fund type for 21 bond
funds and 23 stock funds.

The tree diagram shows all events along with their marginal,
conditional and joint probabilities.
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 Chapter 5
LO7 5.6 Tree Diagrams
Tree Diagram for Fund Type and Expense Ratios

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 Chapter 5
LO8 5.7 Bayes Theorem
LO8: Use Bayes Theorem to compute revised probabilities
Thomas Bayes (1702-1761) provided a method (called Bayess Theorem)
of revising probabilities to reflect new probabilities.
The prior (marginal) probability of an event B is revised after event A has
been considered to yield a posterior (conditional) probability.
P ( A | B )P (B )
Bayess formula is: P (B | A)
P ( A)

In some situations P(A) is not given. Therefore, the most useful and
common form of Bayes Theorem is:

P( A | B)P(B)
P (B | A)
P ( A | B ) P ( B ) P ( A | B ') P ( B ')

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 Chapter 5
LO8 5.7 Bayes Theorem
General Form of Bayes Theorem
A generalization of Bayess Theorem allows event B to have as many
mutually exclusive and collectively exhaustive categories as we wish
(B1, B2, Bn) rather than just two dichotomous categories (B and B').

P( A | Bi ) P( Bi )
P( Bi | A)
P( A | B1 ) P( B1 ) P( A | B2 ) P( B2 ) ... P( A | Bn ) P( Bn )

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 Chapter 5
LO8 5.7 Bayes Theorem
Example: Hospital Trauma Centers

Based on historical data, the percent of cases at 3 hospital trauma

centers and the probability of a case resulting in a malpractice suit
are as follows:

let event A = a malpractice suit is filed

Bi = patient was treated at trauma center i

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 Chapter 5
LO8 5.7 Bayes Theorem
Example: Hospital Trauma Centers

Applying the general form of Bayes Theorem, find P(B1 | A).

P( A | B1 ) P( B1 )
P( B1 | A)
P( A | B1 ) P( B1 ) P( A | B2 ) P( B2 ) P( A | B3 ) P( B3 )

(0.001)(0.50)
P( B1 | A)
(0.001)(0.50) (0.005)(0.30) (0.008)(0.20)

0.0005 0.0005
P( B1 | A) 0.1389
0.0005 0.0015 0.0016 0.00036
0.
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 Chapter 5
LO8 5.7 Bayes Theorem
Example: Hospital Trauma Centers
Conclude that the probability that the malpractice suit was filed in
hospital 1 is .1389 or 13.89%.

All the posterior probabilities for each hospital can be calculated

and then compared:

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 Chapter 5
LO9 5.8 Counting Rules
LO9: Apply counting rules to calculate possible event arrangements.

Fundamental Rule of Counting

If event A can occur in n1 ways and event B can occur in n2 ways,

then events A and B can occur in n1 x n2 ways.

In general, m events can occur

n1 x n2 x x nm ways.

Example: Stock-Keeping Labels

How many unique stock-keeping unit (SKU) labels can a
hardware store create by using 2 letters (ranging from AA to ZZ)
followed by four numbers (0 through 9)?

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 Chapter 5
LO9 5.8 Counting Rules
Example: Stock-Keeping Labels

For example, AF1078: hex-head 6 cm bolts box of 12

RT4855: Lime-A-Way cleaner 16 ounce LL3319: Rust-Oleum
primer gray 15 ounce
There are 26 x 26 x 10 x 10 x 10 x 10 = 6,760,000 unique inventory
labels.

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 Chapter 5
LO9 5.8 Counting Rules
Factorials
The number of ways that n items can be arranged in a particular
order is n factorial.
n factorial is the product of all integers from 1 to n.

n! = n(n1)(n2)...1
Factorials are useful for counting the possible arrangements of any
n items.
There are n ways to choose the first, n-1 ways to choose the
second, and so on.

A home appliance service truck must make 3 stops (A, B, C). In

how many ways could the three stops be arranged?
3! = 3 x 2 x 1 = 6
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 Chapter 5
LO9 5.8 Counting Rules
Permutations
A permutation is an arrangement in a particular order of r randomly
sampled items from a group of n items and is denoted by nPr
n!
n Pr
(n r )!
In other words, how many ways can the r items be arranged, treating
each arrangement as different (i.e., XYZ is different from ZYX)?

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 Chapter 5
LO9 5.8 Counting Rules
Combinations
A combination is an arrangement of r items chosen at random from
n items where the order of the selected items is not important (i.e.,
XYZ is the same as ZYX).
A combination is denoted nCr

n!
nCr
r !(n r )!

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