Introduction to Probability

ASW, Chapter 4
Skip section 4.5

September 17 and 22, 2008

 Why study probability
Inferential statistics – inferences about population
from:
– Sample
– Experiment (or random experiment – ASW, 149)
Economic models are often probabilistic
Quantifying uncertainty for purposes of:
– Prediction
– Assessing preferred course of action
 Definition of probability
Probability is a numerical measure of the
likelihood that an event will occur (ASW, 142).

Notation: The probability of an event E is

written P(E) and pronounced “P of E”
Scale: 0 ≤ P(E) ≤ 1
If P(E) = 0, event E cannot occur
If P(E) = 1, event E is certain to occur
 Terms for probability
• Probability
• Likelihood
• Odds
• Chances
• Risk or hazard
• Random selection
• Random or stochastic processes
 Experiments and outcomes
An experiment is a process that generates well-
defined outcomes (ASW, 142)
– Tossing a coin
– Rolling a single die or a pair of dice
– Applying for a job
– Salary expected after completing a degree
– Drilling an oil well
– Federal election
ASW note that these are sometimes termed
random experiments (150).
 Assigning probabilities
• Classical or theoretical method (ASW, 146)
• Relative frequency method (ASW, 148)
– Data and experiments
• Subjective or judgment method (ASW, 148). A
degree of belief that an outcome will occur
– Best guess / experience / wise judgment produces
good estimates of the chance of a particular
outcome occurring
– Poor guess / poor judgment produces unreliable
estimates of the chance of a particular outcome
occurring
 Classical method
Experiment (eg. Flip of a coin – outcome of H or T)
• Exact outcome is unknown before conducting
experiment
• All possible outcomes of experiment are known
• Each outcome is equally likely
• Experiment can be repeated under uniform
conditions
Together these conditions produce regularities or
patterns in outcomes
 Examples of classical method
• P (2 heads in two tosses of a coin) = 1/4 = 0.250
• P (obtain 4 in roll of one die) = 1/6 = 0.167
• P (total of 4 when rolling two dice) = 3/36 = 1/12 =
0.083
If one randomly selects individuals from a large
population that is ½ male and ½ female:
• P (one male and one female if 2 individuals selected)
= 2/4 = 1/2 = 0.500
• P (two females and one male if 3 individuals
selected) = 3/8 = 0.375
 Relative frequency method
This method used for an experiment where it is
not possible to apply the classical approach
(usually because outcomes not equally likely
or the experiment is not repeatable under
uniform conditions).
The probability of an event E is the relative
frequency of occurrence of E or the
proportion of times E occurs in a large number
of trials of the experiment.
 Example of relative frequency method
If I meet an individual Canadian
Party supported Per cent and I know nothing about this
support person, the best estimate of the
probabilities that the person
supports the various parties are:
Conservative 38
P (individual is a Conservative
supporter) = 0.38
Liberal 27
P (individual supports the Green
NDP 17 Party) = 0.09
Source: http://
Green 9 www.theglobeandmail.com
/national/politics/, 12:15 p.m., Sept.
Bloc Québécois 8 17, 2008
 Subjective or judgment method
• Make your best guess of the likelihood of the event,
based on reliable information and good judgment.
• Inform yourself about the issue or discuss it with
someone knowledgeable.
• Probability is a number between 0 and 1 that
represents your degree of belief the event will occur.
• P(E) close to 0 implies a judgment that the event is
unlikely to occur.
• P(E) close to 1 implies a judgment that the event is
quite likely to occur.
 Examples of subjective method –
my subjective judgment
• P (UR Rams will defeat the SFU Clan this
Saturday) = 0.7
• P (S & P TSX index will increase in trading on
Monday) = 0.3
• P (I will have an auto accident during the next
6 months) = 0.02
• P (some snow will fall in Regina before the
end of October) = 0.97
 Which method to use?
• Whenever it is possible to apply it, use the
classical method.
• When dealing with economic activity, the
classical method often cannot be used (not
equally likely events and not repeatable). Obtain
data and use the relative frequency method.
• If neither of these is possible, use the subjective
method. It is a weak method, but if judgments
are sound, these subjective probabilities can be
used in coordination with economic theory and
more soundly based probabilities.
 Sample space (ASW, 141)
• An experiment is a process that generates well-
defined outcomes.
• The sample space, S, for an experiment is the set
of all experimental outcomes.
• Each of these outcomes is referred to as a sample
point. For an experiment with n sample points,
label these E1, E2, E3, ... , En.
• The sample space of an experiment is the set of
all sample points, ie. S = {E1, E2, E3, ... , En}.
 Two requirements for assigning
probabilities
• If Ei is the ith outcome of an experiment, then its
probability is no less than zero and no greater
than 1. That is, for all sample points or
outcomes, Ei, 0 ≤ P(Ei) ≤ 1, for i = 1, 2, ... n.
• The sum of the probabilities of all the outcomes
equals 1, that is,
P(E1) + P(E2) + P(E3) + ... + P(En) = 1 or


i n
i 1
P ( Ei )  1
 Examples of sample spaces
• Flip a coin (n = 2). S = {H, T}, where H = head, T= tail.
P(H) = 1/2 = 0.50 and P(T) = 1/2 = 0.50.
P(H) + P(T) = 0.50 + 0.50 = 1.
• One roll of a ten-sided die (n = 10). S = {0, 1, 2, 3, 4, 5,
6, 7, 8, 9}.
Probability of each side occurring is 1/10.
P(0) + P(1) + P(2) + ... + P(9) =1.
• Party that will form the government following the
Canadian federal election. S = {C, L, N, G, B} where C =
Conservative, L = Liberal, N = NDP, G = Green, B = Bloc.
What are P(C), P(L), P (N), P(G), P(B)?
P(C) + P(L) + P(N) + P(G) + P(B) = 1.
 Multiple-step experiments
• If an experiment with k steps has n1 possible
outcomes on the first step, n2 possible outcomes
on the second step, etc., then the sample space
has n1 × n2 × n3 × ... × nk sample points (ASW, 143).
• If 3 persons are randomly selected from a large
population with half females and half males,
there are 2 × 2 × 2 = 8 outcomes for the sex of the
persons selected. Each outcome is equally likely.
 Third Sample
selection points Probability
Second
selection F (F, F, F) 1/8 = 0.125
First
selection F •
M (F, F, M) 1/8 = 0.125
F • F (F, M, F) 1/8 = 0.125
M •
• M
F
(F, M, M)
(M, F, F)
1/8 = 0.125
1/8 = 0.125
F • (M, F, M)
M M 1/8 = 0.125
• F (M, M, F) 1/8 = 0.125
Selection of 3 persons M
•
from a large population M (M, M, M) 1/8 = 0.125
of half females and half Sum = 1.000
males.
 Event
• An event is a collection of sample points (ASW,
152).
• The probability of any event is equal to the sum of
the probabilities of the sample points in the event
(ASW, 153).
• Event of selecting exactly two females (2F).
P (2F) = 1/8 + 1/8 + 1/8 = 3/8 = 0.375.
This is the sum of the probabilities of the events
FFM, FMF, and MFF.
 Results from Econ 224 survey
• Sample of N = 46 students.
• Step one – results organized into four groups by
major: Math (including Actuarial and Statistics),
Business, Economics, and Other.
• Step two – results organized into four groups of
experience level with Excel – None (N), Low (L),
Medium (M), or High (H).
• Number of students reporting each characteristic
reported in a tree diagram.
 Step one: Step Two:
Outcome:
Major Excel Skill

N = 46 N=0
Math L=2
(6) M=4
H=0
N=1
Business L=3
MAJOR
(13) M=6
H=3
N=2
Economics L = 12
(24) M=8
H=2
N=0
Other L=1
(3) M=1
 Probabilities for Excel skill levels
If each outcome equally likely, P(E) = NE/N where NE is
the number of outcomes in event E and N is the
total number of outcomes.
Probability of selecting a student with low Excel skills
= (2 + 3 + 12 +1)/46 = 18/46 = 0.391
P(High Excel skills) = 6/46 = 0.130
P(No Excel experience) = 3/46 = 0.065
P(Medium Excel experience) = 19/46 = 0.413
Note that 0.065 + 0.391 + 0.413 + 0.130 = 0.999
 Relationships of Probability
• Complement of an event
• Addition law – intersection and union
• Mutually exclusive
• Conditional probability
• Independence
• Multiplication law
 Complement of an event
• The complement Ac of an event A is the set of
all sample points that are not in event A.
• P(A) + P(Ac) = 1 or P(Ac) = 1 – P(A).
• Examples: The probability that a student in this
class is not an Economics major (E) is 22/46.
P(E) = 24/46 = 0.522
P(Ec) = 1 – 0.522 = 0.478
P(Excel skills not High) = 1 – 0.130 = 0.870
Combining events (ASW, 157-160)
What is the probability that more than one
event has occurred? If there are two events:
Both events could occur – this is referred to as
the intersection of the two events.
At least one of the events could occur – this is
referred to as the union of the two events.
Neither event occurs.
 Union of two events
• The union of events A and B is the event containing
all the sample points of either A or B, or both (ASW,
157).
• The notation for the union is P(AB).
• Read this as “probability of A union B” or the
“probability of A or B.”
• The probability of A or B is the sum of the
probabilities of all the sample points that are in either
A or B, making sure that none are counted twice.
 Intersection of two events
• The intersection of events A and B is the event
containing only the sample points belonging to
both A and B (ASW, 158).
• The notation for the intersection is P(AB).
• Read this as “probability of A intersection B” or
the “probability of A and B.”
• The probability of A and B is the sum of the
probabilities of all the sample points common to
both A and B.
 Addition law (ASW, 158)

P(AB) = P(A) + P(B) – P(AB)

The probability that at least one event occurs is

the probability of one event plus the
probability of the other. But to avoid double
counting, the probability of the intersection of
the two events is subtracted.
 Examples
• Probability of a randomly selected student being an
Economics major (E) or having high Excel skills (H)?
P(EH) = P(E) + P(H) – P(EH)
= 24/46 + 6/46 – 2/46
= 28/46 = 0.609
• Probability of Business (B) or low skills (L)?
P(BL) = P(B) + P(L) – P(BL)
= 28/46 = 0.609
• P(Other or medium) = 0.456
 Mutually exclusive events (ASW, 160)
• Two events are mutually exclusive if the events
have no sample points in common.
• If two events A and B are mutually exclusive, the
probability of A and B is zero.
• In this case, the probability of A or B is the sum of
the probability of A and the probability of B. That
is,
P(AB) = 0 if A and B are mutually exclusive.
Then P(AB) = P(A) + P(B)
Example of mutually exclusive events
If 3 persons are randomly selected from a large
population of half females and half males, what
is the probability of selecting 3 females (A) and at
least 2 males (B)?
Event A has sample point (F, F, F) .
Event B has sample points (F, M, F), (M, F, M),
(M, M, F) and (M, M, M) .
Events A and B have no sample points in
common, so P(AB) = 0.
 Conditional probabilities (ASW, 162-167)
• A conditional probability refers to the
probability of an event A occurring, given that
another event B has occurred.
• Notation: P(A  B)
• Read this as the “conditional probability of A
given B” or the “probability of A given B.“
• These are especially useful in economic analysis
because probabilities of an event differ,
depending on other events occurring.
Formulae for conditional probabilities
• The probability of A given B is

P( A  B)
P( A B) 
P( B)
• The probability of B given A is
P( A  B)
P ( B A) 
P ( A)
 Number of students by major and
Excel skill level

Major of Excel skill level Total

student None (N) Low (L) Medium (M) High (H)

Math (MA) 0 2 4 0 6
Business (B) 1 3 6 3 13
Economics (E) 2 12 8 2 24
Other (O) 0 1 1 1 3
Total 3 18 19 6 46

This table contains the same data as examined earlier, but

reorganized as a table rather than in a tree diagram.
Examples of conditional probabilities from
student survey
• Probability that each major has low skill level?
P(L  MA) = P(L  MA) / P(MA) = (2/46) / (6/46) = 2/6 = 0.333
P(L  B) = 3 / 13 = 0.231
P(L  E) = 0.500
P(L  O) = 0.333
If a student has a high skill level is Excel, what is the probability
his or her major is Business? Other?
P(B  H) = P(B  H) / P(H) = (3/46) / (6/46) = 3/6 = 0.500
P(O  H) = 0.167
 Next day
• Independence (ASW, 166)
• Multiplication law (ASW, 166)
• Random variables (ASW, 186)
• Discrete probability distributions (ASW, 189)
• Expected value – mean and variance (ASW,
195)
• Binomial probability distribution (ASW, 199)