Chapter 4:

Probability & Statistics

Section 4.3:
Expected Value & Fair Price

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Expected Value
 The Expected Value, EV, calculation is used to determine the value of a business venture or a
game over the long run. This is not the value of a particular event. It is the long run average
value if the event was repeated many times.
To find the EV of a multi-stage event, we multiply the probability by the value of each stage and
add those values together. Be sure to pay attention if you are losing money on a specific stage
and, if so, include a “-” for that loss.

EV = P(win) × ($ won) + P(lose) × ($ lost)

Example: Five hundred tickets will be sold for a raffle, at a cost of $2 each. The prize for the
winner is $750. What is the expected value for playing this raffle?
EV = P(win) × ($won) + P(lose) × ($lost)
EV = (1/500) × $748 + (499/500) × (-$2) = = = -$0.50
One ticket is worth $748, and the other 499 are worth -$2. On average, that is -$0.50 each.

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Fair Price
A game is considered to be fair when the expected value is equal to zero.
The fair price to pay, FP, for playing a game can be found by calculating the expected winnings.

FP = P(win) × ($won)

Example: A carnival game has a player reach into a paper bag and select one of four bills at
random. In the bag are two $1 bills, a $10 bill and a $100 bill. What is the fair price to pay for
playing this game? Would you play this game if it cost $20 to play?
FP = P(Drawing $1) × $1 + P(Drawing $10) × $10 + P(Drawing $100) × $100
FP = (2/4)($1) + (1/4)($10) + (1/4)($100) = $112/4 = $28
If it costs $20, play it. The player has the advantage for ANY cost to play less than $28.

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From a Different Point of View
The Expected Value (EV) and Fair Price (FP) calculations are very similar. In fact,
• EV = FP – Cost

Think of the raffle ticket example in which 500 tickets were sold at a cost of $2 each, and the
single prize was $750.
• EV = FP – Cost
• EV = (1/500)($750) - $2 = $1.50 - $2.00 = -$0.50

Also keep in mind:

• If the cost is equal to the FP, the EV = 0, which makes it a fair game.
• If the cost is greater than the FP, the EV is negative from the player’s perspective.
• If the cost is less than the FP, the EV is positive from the player’s perspective.

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