Introduction to Uncertainty

JQY
 Probability and Uncertainty
• Nothing is certain except death and taxes
• All decisions, including business decisions, must deal with uncertainty
• Probability measures this uncertainty by converting it into a number
• This number ranges from 0 to 1 (100%)
• 0%: something is never going to happen; 100%: it will surely happen
• 50%: chance of an event happening or not happening is the same
• How do you get these probabilities?
• Conduct “experiments” which generate an “outcome”
• Each experiment results in one (and only one) experimental outcome
• Run many times to get the complete set of all possible outcomes
• What is the outcome for:
• Tossing a coin? [Heads, Tails]
• Taking AC1103? [Pass, Fail]
• Running a business? [Profit, Break Even, Loss)
 Assigning Probabilities to Experimental Outcomes
• Classical Method: An experiment with 𝑛 possible outcomes will have a probability of
1Τ for each outcome
𝑛
• Used in games of chance where each outcome is equally likely (dice roll)
• Not so useful in business applications
• Relative Frequency: An experiment is performed many times in the same way; the
results are used to generate a frequency distribution
• A survey of 1,000 accountancy students showed that 600 are taking the degree to obtain the CPA
600
license. We then infer that = 60% of students are taking the degree to become future CPAs.
1,000
• If the survey is performed correctly, then we should be able to extrapolate the results to BSA
students as a whole
• This is called relative frequency because repeating the survey with another set of 1,000 students
may give different results
• Subjective Method: use your best judgment (because the outcomes aren’t equally
likely and you don’t have data) to assign probabilities. Each person will assign different
probabilities based on own beliefs
 Events
• An event is a set of outcomes of an experiment which is assigned a probability
• The event is a subset of the entire sample space. Throwing
a six-sided die gives a sample of six equally-likely results
(1,2,3,4,5,6), all outcomes adding up to 100%
• We can define the probability of having a red result (1,4)
as an Event.
• Probability events are illustrated using Venn Diagrams
• The complement of an Event is its inverse: probability of
all outcomes that are not part of the event
• The complement of having a red die result is (2,3,5,6)
• The probabilities of an Event and its complement
c
will be 100%:
P A +P A =1
• Two separate Events may have a relationship that is:
• Mutually-exclusive: Events A and B can occur separately but never together
• Independent: Event A and Event B can occur separately and together
• Conditional: Event A affects the occurrence of Event B
 Unions and Intersections (1)
• There are two types of probability combinations:
• Union: “OR” – probability of Events A or B (or both) occurring
• Intersection: “AND” – probability of Events A and B occurring

A A∪B B A A∩B B

• The Multiplication Law calculates probabilities for Intersections: the probability

of both events occurring
• P A ∩ B = P A × P B if the events are independent
• P A ∩ B = 0 if the events are mutually exclusive
• The Addition Law calculates probabilities for Unions: the probability of at least
one event occurring
• P A ∪ B = P A + P B − P A ∩ B (to avoid double-counting)
• If P A and P B are mutually exclusive, P A ∪ B = P A + P B , since they don’t intersect
so there is nothing to subtract
 Unions and Intersections (2)
Example: In a typical Management Science course of 20 students, 16 (80%) pass
the midterms, and 14 (70%) pass the finals
• What is the probability of a randomly-selected student passing both exams?
16 14
• P A∩B = × = 80% × 70% = 𝟓𝟔%
20 20
• What is the probability of a randomly-selected student passing at least one of the
two exams?
16 14 16 14
• P A∪B = + − × = 80% + 70% − 56% = 𝟗𝟒%
20 20 20 20
• Is this a good real-life example?
• Probably not; if you get a better grade in the midterms, you are more likely to get a better
grade in the finals, all things being equal (e.g. personal motivation, drive, confidence)
• The probability that a student who passed the midterms will pass the finals is likely to be
higher than the probability that a student who failed the midterms will pass the finals – in
other words, the situation has different conditional probabilities
 Conditional Probabilities
• Conditional probabilities apply if both events are dependent; thus the
earlier event affects the later event
• Conditional Probabilities are expressed in this format:
• P A B : Probability of A occurring after B has occurred
• P B A : Probability of B occurring after A has occurred
• According to the Multiplication Law:
P A∩B P A∩B
• P BA = and P A B =
P A P B
• The probability of a randomly-selected student passing both midterms and
finals P A ∩ B is 60%. 80% of the class passed the midterms exam P A .
• What is the probability that someone who passed the midterms also
passed the finals?
P A∩B 60%
• P BA = = = 75%
P A 80%
 Bayesian Inference (1)
• Bayes’ Theorem or Bayes’ Rule (by Rev. Thomas Bayes) allows the
manipulation of conditional probabilities. You can change P B A
to P A B (and vice versa) as long as you know the marginal
outcomes of A (or B).
• In statistics speak, we begin with a set of prior probabilities.
Based from additional information obtained, we then revise the
initial probabilities by calculating posterior probabilities
P(B│A)×P(A)
• Bayes’ Formula: P A B =
P(B)
 Example 1: Bayes’ Theorem
• You are interested in finding out a patient’s probability of having
liver disease if they are an alcoholic. Past data tells you that 10% of
patients entering your clinic have liver disease. Five percent of the
clinic’s patients are alcoholics. Among those patients diagnosed
with liver disease, 7% are alcoholics.
 Example 2: Bayes’ Theorem
• Your company sources 65% of its components from Supplier 1, and 35% from
Supplier 2. Based on past experience, 98% of the components from Supplier 1
are good, while 95% from Supplier 2 are good.
• In a random inspection of all delivered goods in a pile, what is the probability
that a component is from Supplier 2?
• After inspecting the component, it was found to be bad. What is the
probability that the component is from Supplier 2?
 Exercise 1: Bayes’ Theorem
• In a particular pain clinic, 10% of patients are prescribed narcotic pain killers.
Overall, five percent of the clinic’s patients are addicted to narcotics (including
pain killers and illegal substances). Out of all the people prescribed pain pills, 8%
are addicts. If a patient is an addict, what is the probability that they will be
prescribed pain pills?
 Exercise 2: Bayes’ Theorem
• 1% of people have a certain genetic defect
90% of tests for the gene detect the defect (true positives).
9.6% of the tests are false positive
If a person gets a positive test result, what are the odds they actually have the
genetic defect?
 Exercise 3: Bayes’ Theorem
• Given the following statistics, what is the probability that a woman has cancer
if she has a positive mammogram result?
One percent of women over 50 have breast cancer. Ninety percent of women who
have breast cancer test positive on mammograms. Eight percent of women will
have false positives.
 Exercise 4: Bayes’ Theorem
• You are testing dice in a casino to determine how fair it is
• A fair die will roll a ⚂ 1/6 of the time
• A loaded die will roll a ⚂ 3/5 of the time
• You set the initial probability of the die being fair at 50%.
• You roll a ⚄. What is the probability that the dice was loaded?
P F = 50% 5ൗ6 ÷ 50% 5ൗ6 + 50% 2ൗ5 = 𝟑𝟐. 𝟒𝟑%
• You roll a ⚂. What is the probability that the dice was loaded?
P(L) = 50% 3ൗ5 ÷ 50% 1ൗ6 + 50% 3ൗ5 = 𝟕𝟖. 𝟐𝟔%
• Having rolled ⚂, you throw the dice again, and got the same result. What is the
probability the dice was loaded?
P L = 78.26% 3ൗ5 ÷ 1 − 78.26% 1ൗ6 + 78.26% 3ൗ5 = 𝟗𝟐. 𝟖𝟒% ≪ or ≫
2 2 2
3 1
P L = 50% ൗ5 ÷ 50% ൗ6 + 50% ൗ5 3 = 𝟗𝟐. 𝟖𝟒%