Probability: Living with the Odds

Discussion Paragraph 7B

1 web
59. Lottery Chances
60. HIV Probabilities
1 world
61. Combined Probability in the News
62. Combined Probability in Your Life

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Unit 7C

The Law of
Large Numbers

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The Law of Large Numbers

The law of large numbers applies to a process for
which the probability of an event A is P(A) and the
results of repeated trials are independent.

If the process is repeated over many trials, the

proportion of the trials in which event A occurs will
be close to the probability P(A). The larger the
number of trials, the closer the proportion should
be to P(A).

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The Law of Large Numbers

Illustrate the law of large numbers with a die
rolling experiment. The following figure shows the
results of a computer simulation of rolling a die.

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Roulette
CN (1a-b)
 A roulette wheel has 38 numbers: 18 are black, 18
are red, and the numbers 0 and 00 are green.

 a. What is the probability of getting a red number

on any spin?
 b. If patrons in a casino spin the wheel 100,000
times, how many times would you expect a red
number?

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Expected Value
Consider two events, each with its own value and
probability.

Expected Value
= (event 1 value) • (event 1 probability)
+ (event 2 value) • (event 2 probability)

The formula can be extended to any number of

events by including more terms in the sum.

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Expected Value
Example: Suppose an automobile insurance
company sells an insurance policy with an annual
premium of $200. Based on data from past claims,
the company has calculated the following
probabilities:
An average of 1 in 50 policyholders will file a claim of $2,000.
An average of 1 in 20 policyholders will file a claim of $1,000.
An average of 1 in 10 policyholders will file a claim of $500.

Assuming that the policyholder could file any of the

claims above, what is the expected value to the
company for each policy sold?
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Expected Value
Let the $200 premium be positive (income) with a
probability of 1 since there will be no policy without
receipt of the premium. The insurance claims will be
negative (expenses).
The expected value is

(This suggests that if the company sells many

policies, then the return per policy, on average, is
$60.)
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Lottery Expectations
CN (2)
 Suppose that $1 lottery tickets have the following
probabilities: 1 in 5 to win a free ticket (worth $1),
1 in 100 to win $5, 1 in 100,000 to win $1,000 ,
and 1 in 10 million to win $1 million.

 2. What is the expected value of a lottery ticket?

 Discuss the implications. (Note: Winners do not

get back the $1 they spend on the ticket.)

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Art Auction
CN (3)
 You are at an art auction, trying to decide whether
to bid $50,000 for a particular painting. You
believe that you have a ½ probability of reselling
the painting to a client in New York for $70K and
¼ probability of reselling the painting to a client in
San Francisco for $80K. Otherwise you will have
to keep the painting—an option that has benefits,
but not monetary ones.
 3. What is the expected value of a $50,000 bid?

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The Gambler’s Fallacy

The gambler's fallacy is the mistaken belief

that a streak of bad luck makes a person
"due" for a streak of good luck.

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Continued Losses
CN (4)
Suppose you are playing the coin toss game, in which you win $1 for
heads and lose $1 for tails. After 100 tosses you are $10 in the hole
because you flip perhaps 45 heads and 55 tails. The empirical
probability is 0.45 for heads.
So you keep playing the game.
With 1,000 tosses, perhaps you get 490 heads and 510 tails. The
empirical ratio is now 0.49, but you are $20 in the hole at this point.
Because you know the law of averages helps us to know that the
eventual theoretical probability is 0.50, you decide to play the game
just a little more.

4. a. Does the result agree with what we expect from the law of large
numbers?
b. Have you gained back any of your losses? Explain

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The Gambler’s Fallacy
Streaks
 Another common misunderstanding that
contributes to the gambler’s fallacy involved
expectations about streaks.

 Streaks
 For tossing a coin 6 times, the outcomes

HTTHTH and HHHHHH (all heads) are equally

likely.

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Hot hand at the Craps Table
CN (5a-b)
 5. The popular casino game of craps involves
rolling dice. Suppose you are playing craps and
suddenly find yourself with a “hot hand”: You roll
a winner on ten consecutive bets.
 a. Is your hand really “Hot”?
 b. Should you increase your bet because you are
on a hot streak?

 Assume you are making bets with a .486 probability of

winning on a single play (the best odds available in craps).

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The Gambler’s Fallacy
The House Edge
 A casino makes money because games are set
up so that the expected earnings of patrons are
negative (that is losses). Because the casino
earns whatever patrons lose, the casino’s
earnings are positive.

 The House Edge

 The expected value to the casino of a particular

bet

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The House Edge in Roulette
CN (6a-b)
 6. The game of roulette is usually set up so that
betting on red is a 1 to 1 bet. That is, you win the
same amount of money as you bet if red comes
up. Betting on a single number is a 35 to 1 bet.
That is, you win 35 times as much as you bet if
your number comes up.
 a. What is the house edge in each of these two
cases?
 b. If patrons wager $1 million on such bets, how
much should the casino expect to earn?

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Quick Quiz
CN (7)

 7. Please answer the 10 quick quiz multiple

choice questions on p. 445.

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Homework 7C
 Discussion Paragraph 7B
 Class Notes 1-7
 p. 445: 1-12
 1 web
 39. Lotteries

 40. The Morality of Gambling

 1 world
 41. Law of Large Numbers

 42. Personal Law of Large Numbers

 43. The Gambler’s Fallacy

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