Probability

Random Experiments
Sample Space
A random experiment is an observational process whose results cannot be known in advance.
For example, when a customer enters a Lexus dealership, will the customer buy a car or not?
How much will the customer spend? The set of all possible outcomes (denoted S) is the
sample space for the experiment. Some sample spaces can be enumerated easily, while others
may be immense or impossible to enumerate. For example, when CitiBank makes a
consumer loan, we might define a sample space with only two outcomes:

S = {default, no default} The sample space describing a Walmart customer’s payment

method might have four outcomes:
S = {cash, debit card, credit card, check}
The sample space to describe rolling a die has six outcomes:

When two dice are rolled, the sample space consists of 36 outcomes, each of which is a pair:
Event

Probability

What is ‘probability’?
There are three distinct ways of assigning probability, listed in Table 5.1. Many people mix them up or
use them interchangeably; however, each approach must be considered separately
Empirical Approach
Classical Approach
Statisticians use the term a priori to refer to the process of assigning probabilities before we actually
observe the event or try an experiment. 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, we can use deduction to determine P(A). This is the classical approach to probability. For
example, in the sample space for the

Sample Space for rolling two dice

Subjective Approach
A subjective probability reflects someone’s informed judgment about the likelihood of an event. The
subjective approach to probability is needed when there is no repeatable random experiment. For
example:
• What is the probability that Ford’s new supplier of plastic fasteners will be able to meet the September
23 shipment deadline?
• 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 Ford’s stock will rise within the next 30 days?

Exercises
Rules of Probability
Complement of an Event

Complement of an Event A

Union of two Events

Intersection of two Events
The intersection of two events 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. The intersection of A and B is denoted.

General Law of addition

The general law of addition says that the probability of the union of two events A and B is the sum of
their probabilities less the probability of their intersection.

Example:
Mutually Exclusive Event

Special Law of Addition

Collective Exhaustive Events

Conditional Probability

General law of multiplication

Example:
Exercises:

Independent Events

When P(A) differs from P(A | B), the events are dependent. You can easily think of examples of
dependence. For example, cell phone text messaging is more common among young people,
while arteriosclerosis is more common among older people. Therefore, knowing a person’s age
would affect the probability that the individual uses text messaging or has arteriosclerosis.
Dependent events may be causally related, but statistical dependence does not
prove cause and effect. It only means that knowing that event B has occurred will affect the
probability that event A will occur.
When knowing that event B has occurred does not affect the probability that event A will occur,
then events A and B are independent. In other words, event A is independent of event B if the
conditional probability P(A | B) is the same as the unconditional probability P(A); that is, if the
probability of event A is the same whether event B occurs or not. For example, if text messaging
among high school students is independent of gender, this means that knowing whether a student
is a male or female does not change the probability that the student uses text messaging.

If A and B are independent events, we can simplify the general law of multiplication (formula 5.10) to show that the
joint probability of events A and B is the product of their individual probabilities. Recall the general law of
multiplication:
If A and B are independent, then we can substitute P(A) for P(A | B). The result is shown in formula 5.12, the special
law of multiplication

Contingency table

Inspection of this table reveals that MBA graduates of the high-tuition schools do tend to have large salary gains (15
of the 67 schools) and that about half of the top-tier schools charge high tuition (32 of 67 schools). We can make
more precise interpretations of these data by applying the concepts of probability.

Margin Probabilities
Tree Diagrams
Bayes Theorem