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A Decision-Making Approach

6th Edition

Chapter 4

Using Probability and

Probability Distributions

Hall, Inc. Chap 4-1

Chapter Goals

After completing this chapter, you should be

able to:

Explain three approaches to assessing

probabilities

Apply common rules of probability

probability distributions

Compute the expected value and standard

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-2

Important Terms

will occur (always between 0 and 1)

Experiment – a process of obtaining outcomes

for uncertain events

Elementary Event – the most basic outcome

possible from a simple experiment

Sample Space – the collection of all possible

elementary outcomes

Hall, Inc. Chap 4-3

Sample Space

The Sample Space is the collection of all

possible outcomes

e.g. All 6 faces of a die:

Hall, Inc. Chap 4-4

Events

space with one characteristic

Example: A red card from a deck of cards

simultaneously

Example: An ace that is also red from a deck of

cards

Hall, Inc. Chap 4-5

Visualizing Events

Contingency Tables

Ace Not Ace Total

Black 2 24 26

Red 2 24 26

Total 4 48 52

Tree Diagrams Sample

Sample

Ac e 2 Space

C ar d

Space

Bl ac k 24

Full Deck Not an Ace

of 52 Cards Ace

Re d C 2

ard

No t a n

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc.

Ace 24 Chap 4-6

Elementary Events

A automobile consultant records fuel type and

vehicle type for a sample of vehicles

2 Fuel types: Gasoline, Diesel

3 Vehicle types: Truck, Car, SUV

k e1

6 possible elementary events: Truc

Car e2

e1 Gasoline, Truck l ine

s o

e2 Gasoline, Car Ga SUV

e3

e3 Gasoline, SUV Die Truc

k

e4

s el Car

e4 Diesel, Truck

e5

e5 Diesel, Car SUV

e6 Diesel, SUV e6

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-7

Probability Concepts

If E1 occurs, then E2 cannot occur

E1 and E2 have no common elements

E2 A card cannot be

E1

Black and Red at

Red the same time.

Black Cards

Cards

Hall, Inc. Chap 4-8

Probability Concepts

Independent: Occurrence of one does not

influence the probability of

occurrence of the other

probability of the other

Hall, Inc. Chap 4-9

Independent vs. Dependent

Events

Independent Events

E1 = heads on one flip of fair coin

E2 = heads on second flip of same coin

Result of second flip does not depend on the result of

the first flip.

Dependent Events

E1 = rain forecasted on the news

E2 = take umbrella to work

Probability of the second event is affected by the

occurrence of the first event

Hall, Inc. Chap 4-10

Assigning Probability

Classical Probability Assessment

Number of ways Ei can occur

P(Ei) =

Total number of elementary events

Number of times Ei occurs

Relative Freq. of Ei =

N

An opinion or judgment by a decision maker about

the likelihood of an event

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-11

Rules of Probability

Rules for

Possible Values

and Sum

k

0 ≤ P(ei) ≤ 1

∑ P(e ) = 1

i

For any event ei i=1

where:

k = Number of elementary events

in the sample space

ei = ith elementary event

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-12

Addition Rule for Elementary

Events

sum of the probabilities of the elementary

events forming Ei.

then:

P(Ei) = P(e1) + P(e2) + P(e3)

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-13

Complement Rule

The complement of an event E is the collection of

all possible elementary events not contained in

event E. The complement of event E is

represented by E.

E

Complement Rule:

P( E ) = 1 − P(E) E

Or, P(E) + P( E ) = 1

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-14

Addition Rule for Two Events

■ Addition Rule:

P(E1 or E2) = P(E1) + P(E2) - P(E1 and E2)

E1 + E2 = E1 E2

Don’t count common

elements twice!

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-15

Addition Rule Example

Don’t count

the two red

Color aces twice!

Type Red Black Total

Ace 2 2 4

Non-Ace 24 24 48

Total 26 26 52

Hall, Inc. Chap 4-16

Addition Rule for

Mutually Exclusive Events

If E1 and E2 are mutually exclusive, then

So

0 ally

= utu ve i

if mclus

P(E1 or E2) = P(E1) + P(E2) - P(E1 and E2) ex

= P(E1) + P(E2)

Hall, Inc. Chap 4-17

Conditional Probability

two events E1 , E2:

P(E1 and E 2 )

P(E1 | E 2 ) =

P(E 2 )

Hall, Inc. Chap 4-18

Conditional Probability

Example

conditioning (AC) and 40% have a CD player

(CD). 20% of the cars have both.

player, given that it has AC ?

Hall, Inc. Chap 4-19

Conditional Probability

Example

(continued

Of the cars on a used car lot, 70% have air conditioning

)

(AC) and 40% have a CD player (CD).

20% of the cars have both.

CD No CD Total

AC .2 .5 .7

No AC .2 .1 .3

Total .4 .6 1.0

P(CD | AC) = = = .2857

P(AC) .7

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-20

Conditional Probability

Example

(continued

)

Given AC, we only consider the top row (70% of the cars). Of these,

20% have a CD player. 20% of 70% is about 28.57%.

CD No CD Total

AC .2 .5 .7

No AC .2 .1 .3

Total .4 .6 1.0

P(CD | AC) = = = .2857

P(AC) .7

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-21

For Independent Events:

Conditional probability for

independent events E1 , E2:

Hall, Inc. Chap 4-22

Multiplication Rules

and the multiplication rule simplifies to

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-23

Tree Diagram Example

.2

|E )=0 P(E1 and E3) = 0.8 x 0.2 = 0.16

k: P (E 3 1

Truc

Car: P(E4|E1) = 0.5 P(E1 and E4) = 0.8 x 0.5 = 0.40

Gasoline

SUV:

P(E1) = 0.8 P(E |E

5 1 ) = 0. P(E1 and E5) = 0.8 x 0.3 = 0.24

3

: P(E 3 2

Diesel Truck

P(E2) = 0.2 Car: P(E4|E2) = 0.1

P(E2 and E4) = 0.2 x 0.1 = 0.02

SUV:

P(E |E

5 2 ) = 0.

3 P(E3 and E4) = 0.2 x 0.3 = 0.06

Hall, Inc. Chap 4-24

Bayes’ Theorem

P(Ei )P(B | Ei )

P(Ei | B) =

P(E1 )P(B | E1 ) + P(E 2 )P(B | E 2 ) + + P(Ek )P(B | Ek )

where:

Ei = ith event of interest of the k possible events

B = new event that might impact P(Ei)

Events E1 to Ek are mutually exclusive and collectively

exhaustive

Hall, Inc. Chap 4-25

Bayes’ Theorem Example

chance of striking oil for their new well.

A detailed test has been scheduled for more

information. Historically, 60% of successful

wells have had detailed tests, and 20% of

unsuccessful wells have had detailed tests.

Given that this well has been scheduled for a

detailed test, what is the probability

that the well will be successful?

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-26

Bayes’ Theorem Example

(continued

)

Let S = successful well and U = unsuccessful well

P(S) = .4 , P(U) = .6 (prior probabilities)

Define the detailed test event as D

Conditional probabilities:

P(D|S) = .6 P(D|U) = .2

Revised probabilities

Prior Conditional Joint Revised

Event Prob.

Prob. Prob. Prob.

S (successful) .4 .6 .4*.6 = .24 .24/.36 = .67

U (unsuccessful) .6 .2 .6*.2 = .12 .12/.36 = .33

Hall, Inc.

Sum = .36 Chap 4-27

Bayes’ Theorem Example

(continued

)

Given the detailed test, the revised probability

of a successful well has risen to .67 from the

original estimate of .4

Event Prob.

Prob. Prob. Prob.

S (successful) .4 .6 .4*.6 = .24 .24/.36 = .67

U (unsuccessful) .6 .2 .6*.2 = .12 .12/.36 = .33

Sum = .36

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-28

Introduction to Probability

Distributions

Random Variable

Represents a possible numerical value from

a random event

Random

Variables

Discrete Continuous

Random Variable Random Variable

Hall, Inc. Chap 4-29

Discrete Random

Variables

Can only assume a countable number of values

Examples:

Let x be the number of times 4 comes up

(then x could be 0, 1, or 2 times)

Let x be the number of heads

(then x = 0, 1, 2, 3, 4, or 5)

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-30

Discrete Probability

Distribution

4 possible outcomes

Probability Distribution

T T x Value Probability

0 1/4 = .25

T H 1 2/4 = .50

2 1/4 = .25

H T

Probability

.50

H H .25

Hall, Inc.

0 1 2 x Chap 4-31

Discrete Probability

Distribution

A list of all possible [ xi , P(xi) ] pairs

xi = Value of Random Variable (Outcome)

P(xi) = Probability Associated with Value

xi’s are mutually exclusive

(no overlap)

xi’s are collectively exhaustive

(nothing left out)

0 ≤ P(xi) ≤ 1 for each xi

Σ P(xi) = 1

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-32

Discrete Random Variable

Summary Measures

Expected Value of a discrete distribution

(Weighted Average)

Example: Toss 2 coins, x P(x)

x = # of heads, 0 .25

compute expected value of x: 1 .50

2 .25

E(x) = (0 x .25) + (1 x .50) + (2 x .25)

= 1.0

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-33

Discrete Random Variable

Summary Measures

(continued

)

Standard Deviation of a discrete distribution

σx = ∑ {x − E(x)} P(x) 2

where:

E(x) = Expected value of the random variable

x = Values of the random variable

P(x) = Probability of the random variable having

the value of x

Hall, Inc. Chap 4-34

Discrete Random Variable

Summary Measures

(continued

)

Example: Toss 2 coins, x = # heads,

compute standard deviation (recall E(x) = 1)

σx = ∑ {x − E(x)} P(x) 2

0, 1, or 2

Hall, Inc. Chap 4-35

Two Discrete Random

Variables

Expected value of the sum of two discrete

random variables:

= Σ x P(x) + Σ y P(y)

variables is the sum of the two expected

values)

Hall, Inc. Chap 4-36

Covariance

Covariance between two discrete random

variables:

where:

xi = possible values of the x discrete random variable

yj = possible values of the y discrete random variable

P(xi ,yj) = joint probability of the values of xi and yj occurring

Hall, Inc. Chap 4-37

Interpreting Covariance

Covariance between two discrete random

variables:

Hall, Inc. Chap 4-38

Correlation Coefficient

The Correlation Coefficient shows the

strength of the linear association between

two variables

σxy

ρ=

σx σy

where:

ρ = correlation coefficient (“rho”)

σxy = covariance between x and y

σx = standard deviation of variable x

σy = standard deviation of variable y

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-39

Interpreting the

Correlation Coefficient

The Correlation Coefficient always falls

between -1 and +1

ρ=0 x and y are not linearly related.

relationship:

ρ = -1 x and y have a perfect negative linear relationship

Hall, Inc. Chap 4-40

Chapter Summary

Described approaches to assessing probabilities

Developed common rules of probability

Used Bayes’ Theorem for conditional

probabilities

Distinguished between discrete and continuous

probability distributions

Examined discrete probability distributions and

their summary measures

Business Statistics: A Decision-Making Approach, 6e © 2005 Prentice-

Hall, Inc. Chap 4-41

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