Type author name/s here

Dougherty

Introduction to Econometrics,
5th edition
Chapter heading
Review: Random Variables,
Sampling, Estimation, and
Inference

© Christopher Dougherty, 2016. All rights reserved.

 CONTINUOUS RANDOM VARIABLES

probability

2 3 4 5 6 5 4 3 2
1 1
__ __ __ __ __ __ __ __ __
36 36
36 36 36 36 36 36 36 36 36

2 3 4 5 6 7 8 9 10 11 12 X

A discrete random variable is one that can take only a finite set of values. The sum of the
numbers when two dice are thrown is an example.

1
 CONTINUOUS RANDOM VARIABLES

probability

2 3 4 5 6 5 4 3 2
1 1
__ __ __ __ __ __ __ __ __
36 36
36 36 36 36 36 36 36 36 36

2 3 4 5 6 7 8 9 10 11 12 X

Each value has associated with it a finite probability, which you can think of as a ‘packet’ of
probability. The packets sum to unity because the variable must take one of the values.

2
 CONTINUOUS RANDOM VARIABLES

height

55 60 65 70 75 X

However, most random variables encountered in econometrics are continuous. They can
take any one of an infinite set of values defined over a range (or possibly, ranges).

3
 CONTINUOUS RANDOM VARIABLES

height

55 60 65 70 75 X

As a simple example, take the temperature in a room. We will assume that it can be
anywhere from 55 to 75 degrees Fahrenheit with equal probability within the range.

4
 CONTINUOUS RANDOM VARIABLES

height

55 60 65 70 75 X

In the case of a continuous random variable, the probability of it being equal to a given
finite value (for example, temperature equal to 55.473927) is always infinitesimal.

5
 CONTINUOUS RANDOM VARIABLES

height

55 60 65 70 75 X

For this reason, you can only talk about the probability of a continuous random variable
lying between two given values. The probability is represented graphically as an area.

6
 CONTINUOUS RANDOM VARIABLES

height

55 56 60 65 70 75 X

For example, you could measure the probability of the temperature being between 55 and
56, both measured exactly.

7
 CONTINUOUS RANDOM VARIABLES

height

0.05

55 56 60 65 70 75 X

Given that the temperature lies anywhere between 55 and 75 with equal probability, the
probability of it lying between 55 and 56 must be 0.05.

8
 CONTINUOUS RANDOM VARIABLES

height

0.05

55 56 57 60 65 70 75 X

Similarly, the probability of the temperature lying between 56 and 57 is 0.05.

9
 CONTINUOUS RANDOM VARIABLES

height

0.05

55 56 5758 60 65 70 75 X

And similarly for all the other one-degree intervals within the range.

10
 CONTINUOUS RANDOM VARIABLES

height

0.05

55 565758 60 65 70 75 X

The probability per unit interval is 0.05 and accordingly the area of the rectangle
representing the probability of the temperature lying in any given unit interval is 0.05.

11
 CONTINUOUS RANDOM VARIABLES

height

0.05

55 565758 60 65 70 75 X

The probability per unit interval is called the probability density and it is equal to the height
of the unit-interval rectangle.

12
 CONTINUOUS RANDOM VARIABLES

f(X) = 0.05 for 55  X  75

height f(X) = 0 for X < 55 and X > 75

0.05

55 565758 60 65 70 75 X

Mathematically, the probability density is written as a function of the variable, for example
f(X). In this example, f(X) is 0.05 for 55 < X < 75 and it is zero elsewhere.

13
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 0.05 for 55  X  75

density f(X) = 0 for X < 55 and X > 75
f(X)

0.05

55 565758 60 65 70 75 X

The vertical axis is given the label probability density, rather than height. f(X) is known as
the probability density function and is shown graphically in the diagram as the thick black
line.
14
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 0.05 for 55  X  75

density f(X) = 0 for X < 55 and X > 75
f(X)

0.05

55 60 65 70 75 X

Suppose that you wish to calculate the probability of the temperature lying between 65 and
70 degrees.

15
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 0.05 for 55  X  75

density f(X) = 0 for X < 55 and X > 75
f(X)

0.05

55 60 65 70 75 X

To do this, you should calculate the area under the probability density function between 65
and 70.

16
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 0.05 for 55  X  75

density f(X) = 0 for X < 55 and X > 75
f(X)

0.05

55 60 65 70 75 X

Typically you have to use the integral calculus to work out the area under a curve, but in
this very simple example all you have to do is calculate the area of a rectangle.

17
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 0.05 for 55  X  75

density f(X) = 0 for X < 55 and X > 75
f(X)

0.05

0.25

55 56 60 65 70 75 X

The height of the rectangle is 0.05 and its width is 5, so its area is 0.25.

18
 CONTINUOUS RANDOM VARIABLES

probability
density
f(X)

65 70 75 X

Now suppose that the temperature can lie in the range 65 to 75 degrees, with uniformly
decreasing probability as the temperature gets higher.

19
 CONTINUOUS RANDOM VARIABLES

probability
density
f(X)
0.20

0.15

0.10

0.05

65 70 75 X

The total area of the triangle is unity because the probability of the temperature lying in the
65 to 75 range is unity. Since the base of the triangle is 10, its height must be 0.20.

20
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 1.50 – 0.02X for 65  X  75

density f(X) = 0 for X < 65 and X > 75
f(X)
0.20

0.15

0.10

0.05

65 70 75 X

In this example, the probability density function is a line of the form f(X) = b1 + b2X. To pass
through the points (65, 0.20) and (75, 0), b1 must equal 1.50 and b2 must equal -0.02.

21
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 1.50 – 0.02X for 65  X  75

density f(X) = 0 for X < 65 and X > 75
f(X)
0.20

0.15

0.10

0.05

65 70 75 X

Suppose that we are interested in finding the probability of the temperature lying between
65 and 70 degrees.

22
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 1.50 – 0.02X for 65  X  75

density f(X) = 0 for X < 65 and X > 75
f(X)
0.20

0.15

0.10

0.05

65 70 75 X

We could do this by evaluating the integral of the function over this range, but there is no
need.

23
 CONTINUOUS RANDOM VARIABLES

probability f(X) = 1.50 – 0.02X for 65  X  75

density f(X) = 0 for X < 65 and X > 75
f(X)
0.20

0.15

0.10

0.05

65 70 75 X

It is easy to show geometrically that the answer is 0.75. This completes the introduction to
continuous random variables.

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Copyright Christopher Dougherty 2016.

These slideshows may be downloaded by anyone, anywhere for personal use.

Subject to respect for copyright and, where appropriate, attribution, they may be
used as a resource for teaching an econometrics course. There is no need to
refer to the author.

The content of this slideshow comes from Section R.3 of C. Dougherty,

Introduction to Econometrics, fifth edition 2016, Oxford University Press.
Additional (free) resources for both students and instructors may be
downloaded from the OUP Online Resource Centre
http://www.oxfordtextbooks.co.uk/orc/dougherty5e/

Individuals studying econometrics on their own who feel that they might benefit
from participation in a formal course should consider the London School of
Economics summer school course
EC212 Introduction to Econometrics
http://www2.lse.ac.uk/study/summerSchools/summerSchool/Home.aspx
or the University of London International Programmes distance learning course
EC2020 Elements of Econometrics
www.londoninternational.ac.uk/lse.

2015.12.17