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7-1
Probability Distributions
Random Variables: Working with
Uncertain Numbers
Slide
7-2 Random Variable
• A specification or description of a numerical result
from a random experiment
• The number is the observation of the random variable
• The random variable is the meaning of the number
• The observed value is 17 for the random variable
“Last week’s warranty returns (number of customers)”
• Examples
• Today’s stock market close
• The number of defective parts produced today
• Next quarter’s sales
• Summaries: = mean (expected value)
= standard deviation
Slide
7-3 Examples of Random Variables
Random Standard
Variable Mean Deviation
X = $1.40 $1.40 $0
$1 prob 0.5
Y= { $2 prob 0.5
$1.50 $0.50
$0 prob 0.98
Z= { $95 prob 0.02
$1.90 $13.30
Slide
7-4 Discrete Random Variable
• Can list all possible outcomes
• Probability Distribution
• The list of values and probabilities. Use it to compute!
• Mean (expected value) of random variable X
= Sum of Value Prob of Value = E(X) = XP(X)
Gives a typical or central value of the random variable
• Standard deviation of random variable X
= Sum of (Value – )2 Probability of Value
= ( X - ) 2
P( X )
Tells about how far from expected this random variable will be
Slide
7-5 Example: Investment Payoffs
• Probability distribution of investment payoffs
Payoff (Value) Probability
$0 0.98
$95 0.02
= 0 0.98 + 95 0.02 = $1.90
• The expected payoff is $1.90
• A compromise between $0 (most of the time) and $95 (rarely)
0.3 OK
Great
0.2 Lousy
0.1
0.0
-5 0 5 10
Profit ($millions)
Standard deviation:
$4.40 million Expected profit: $3.65 million
Slide
7-7 Binomial Distribution
• A special type of discrete random variable
• e.g., Interview 50 random customers
• How many like the new product? 0, 1, 2, …, 49, or 50
• e.g., What percent of stocks went up yesterday?
• X is binomial if it is the number of occurrences of
some event, out of n trials, provided that
• The probability is the same for all trials, and
• The trials are independent of one another
• so that each trial brings new, independent information
Number of Proportion or
Occurrences, X Percent, p = X/n
Mean X = n p =
Slide
7-13 Probability: Area Under the Curve
• Probability of observing a value between a and b
is area under the curve
More likely
Less likely
a b a b
• Note: total area = 1
Probability = 0.50
Slide
7-14 Standard Normal Distribution
• Normal with mean = 0 and std. deviation = 1
-3 -2 -1 0 1 2 3
• Standard normal probability table
• Gives probability that a standard normal is less than a
given value
Probability Examples
= 0.3085 Value Probability
–1 0.1587
0 0.5
-3 -2 -1 0 1 2 3 1 0.8413
Value = –0.5 2 0.9772
Slide
7-15 Finding Normal Probabilities
• Example: Sales are forecast as $80 million (mean) with a standard
deviation of $10 million. Find the probability that sales will exceed
$86 million, assuming a normal distribution
• Figure out the question
• Find Prob(X>86) where =80 and = 10
• Standardize (Subtract , divide by to get std. normal)
X– 86–80
• Prob ( >
10
)
Standard
= Prob (
normal > 0.60)
• Draw Picture
-3 -2 -1 0 1 2 3
0.60