Statistics for Business and Economics (13e)

Statistics for
Business and Economics (13e)
Anderson, Sweeney, Williams, Camm, Cochran
© 2017 Cengage Learning

Slides by John Loucks

St. Edwards University

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or 1
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 Statistics for Business and Economics (13e)

Chapter 4
Introduction to Probability
• Random Experiments, Counting Rules, and Assigning Probabilities
• Events and Their Probability
• Some Basic Relationships of Probability
• Conditional Probability
• Bayes’ Theorem

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 Statistics for Business and Economics (13e)

Uncertainties
• Managers often base their decisions on an analysis of uncertainties such
as the following:
• What are the chances that sales will decrease if we increase prices?
• What is the likelihood a new assembly method will increase
productivity?
• What are the odds that a new investment will be profitable?

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 Statistics for Business and Economics (13e)

Probability
• Probability is a numerical measure of the likelihood that an event will
occur.
• Probability values are always assigned on a scale from 0 to 1.
• A probability near zero indicates an event is quite unlikely to occur.
• A probability near one indicates an event is almost certain to occur.

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 Statistics for Business and Economics (13e)

Probability as a Numerical Measure

of the Likelihood of Occurrence

Increasing Likelihood of Occurrence

Probability: 0 .5 1

The event The occurrence The event

is very of the event is is almost
unlikely just as likely as certain
to occur. it is unlikely. to occur.

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 Statistics for Business and Economics (13e)

Statistical Experiments
• In statistics, the notion of an experiment differs somewhat from that of
an experiment in the physical sciences.
• In statistical experiments, probability determines outcomes.
• Even though the experiment is repeated in exactly the same way, an
entirely different outcome may occur.
• For this reason, statistical experiments are sometimes called random
experiments.

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 Statistics for Business and Economics (13e)

Random Experiment and Its Sample Space

• A Random experiment is a process that generates well-defined
experimental outcomes.
• The sample space for an experiment is the set of all experimental outcomes.
• An experimental outcome is also called a sample point.

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 Statistics for Business and Economics (13e)

Random Experiment and Its Sample Space

Experiment Experiment Outcomes
Toss a coin Head, tail
Inspect a part Defective, non-defective
Conduct a sales call Purchase, no purchase
Roll a die 1, 2, 3, 4, 5, 6
Play a football game Win, lose, tie

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 Statistics for Business and Economics (13e)

Random Experiment and Its Sample Space

• Example: Bradley Investments
Bradley has invested in two stocks, Markley Oil and Collins Mining. Bradley
has determined that the possible outcomes of these investments three
months from now are as follows:

Investment Gain or Loss

in 3 Months (in $1000s)
Markley Oil Collins Mining
10 8
5 -2
0
-20

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 Statistics for Business and Economics (13e)

A Counting Rule for Multiple-Step Experiments

• If an experiment consists of a sequence of k steps in which there are n1
possible results for the first step, n2 possible results for the second step, and
so on, then the total number of experimental outcomes is given by (n1)(n2) . .
. (nk).
• A helpful graphical representation of a multiple-step experiment is a tree
diagram.

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 Statistics for Business and Economics (13e)

A Counting Rule for Multiple-Step Experiments

• Example: Bradley Investments
• Bradley Investments can be viewed as a two-step experiment. It involves
two stocks, each with a set of experimental outcomes.
Markley Oil: n1 = 4
Collins Mining: n2 = 2
Total Number of
Experimental Outcomes: n1n2 = (4)(2) = 8

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 Statistics for Business and Economics (13e)

Tree Diagram
• Example: Bradley Investments
Markley Oil Collins Mining Experimental
(Stage 1) (Stage 2) Outcomes
Gain 8 (10, 8) Gain $18,000
(10, -2) Gain $8,000
Gain 10 Lose 2
Gain 8 (5, 8) Gain $13,000
Lose 2 (5, -2) Gain $3,000
Gain 5
Gain 8 (0, 8) Gain $8,000
0
(0, -2) Lose $2,000
Lose 20 Lose 2
Gain 8 (-20, 8) Lose $12,000
Lose 2 (-20, -2) Lose $22,000

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 Statistics for Business and Economics (13e)

Counting Rule for Combinations

• Number of Combinations of N Objects Taken n at a Time
• A second useful counting rule enables us to count the number of
experimental outcomes when n objects are to be selected from a set of
N objects.
𝑁 𝑁 𝑁!
𝐶 = =
𝑛 𝑛 𝑛! 𝑁−𝑛 !

where: N! = N(N - 1)(N - 2) . . . (2)(1)

n! = n(n - 1)(n - 2) . . . (2)(1)
0! = 1

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 Statistics for Business and Economics (13e)

Counting Rule for Permutations

• Number of Permutations of N Objects Taken n at a Time
• A third useful counting rule enables us to count the number of
experimental outcomes when n objects are to be selected from a set of
N objects, where the order of selection is important.

𝑁 𝑁 𝑁!
𝑃 = 𝑛! =
𝑛 𝑛 𝑁−𝑛 !

where: N! = N(N - 1)(N - 2) . . . (2)(1)

n! = n(n - 1)(n - 2) . . . (2)(1)
0! = 1

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 Statistics for Business and Economics (13e)

Assigning Probabilities
• Basic Requirements for Assigning Probabilities
1. The probability assigned to each experimental outcome must be
between 0 and 1, inclusively.
0 < P(Ei) < 1 for all i

where: Ei is the i th experimental outcome

and P(Ei) is its probability

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 Statistics for Business and Economics (13e)

Assigning Probabilities
• Basic Requirements for Assigning Probabilities
2. The sum of the probabilities for all experimental outcomes must equal 1.

P(E1) + P(E2) + . . . + P(En) = 1

where: n is the number of experimental outcomes

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 Statistics for Business and Economics (13e)

Assigning Probabilities
• Classical Method
Assigning probabilities based on the assumption of equally likely
outcomes

• Relative Frequency Method

Assigning probabilities based on experimentation or historical data
• Subjective Method
Assigning probabilities based on judgment

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 Statistics for Business and Economics (13e)

Classical Method
• Example: Rolling a Die
If an experiment has n possible outcomes, the classical method would
assign a probability of 1/n to each outcome.
Experiment: Rolling a die
Sample Space: S = {1, 2, 3, 4, 5, 6}
Probabilities: Each sample point has a 1/6 chance of occurring

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 Statistics for Business and Economics (13e)

Relative Frequency Method

• Example: Lucas Tool Rental
Lucas Tool Rental would like to assign probabilities to the number of car
polishers it rents each day. Office records show the following frequencies of
daily rentals for the last 40 days.
Number of Number
Polishers Rented of Days
0 4
1 6
2 18
3 10
4 2

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 Statistics for Business and Economics (13e)

Relative Frequency Method

• Example: Lucas Tool Rental
Each probability assignment is given by dividing the frequency (number
of days) by the total frequency (total number of days).

Number of Number
Polishers Rented of Days Probability
0 4 .10 = 4/40
1 6 .15
2 18 .45
3 10 .25
4 2 .05
40 1.00

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 Statistics for Business and Economics (13e)

Subjective Method
• When economic conditions or a company’s circumstances change rapidly it
might be inappropriate to assign probabilities based solely on historical data.
• We can use any data available as well as our experience and intuition, but
ultimately a probability value should express our degree of belief that the
experimental outcome will occur.
• The best probability estimates often are obtained by combining the estimates
from the classical or relative frequency approach with the subjective estimate.

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 Statistics for Business and Economics (13e)

Subjective Method
• Example: Bradley Investments
An analyst made the following probability estimates.
Experimental Outcome Net Gain or Loss Probability
(10, 8) $18,000 Gain .20
(10, -2) $8,000 Gain .08
(5, 8) $13,000 Gain .16
(5, -2) $3,000 Gain .26
(0, 8) $8,000 Gain .10
(0, -2) $2,000 Loss .12
(-20, 8) $12,000 Loss .02
(-20, -2) $22,000 Loss .06
1.00
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 Statistics for Business and Economics (13e)

Events and Their Probabilities

• An event is a collection of sample points.
• The probability of any event is equal to the sum of the probabilities of the
sample points in the event.
• If we can identify all the sample points of an experiment and assign a
probability to each, we can compute the probability of an event.

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 Statistics for Business and Economics (13e)

Events and Their Probabilities

• Example: Bradley Investments
Event M = Markley Oil Profitable
M = {(10, 8), (10, -2), (5, 8), (5, -2)}
P(M) = P(10, 8) + P(10, -2) + P(5, 8) + P(5, -2)
= .20 + .08 + .16 + .26
= .70

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or 24
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 Statistics for Business and Economics (13e)

Events and Their Probabilities

• Example: Bradley Investments
Event C = Collins Mining Profitable
C = {(10, 8), (5, 8), (0, 8), (-20, 8)}
P(C) = P(10, 8) + P(5, 8) + P(0, 8) + P(-20, 8)
= .20 + .16 + .10 + .02
= .48

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 Statistics for Business and Economics (13e)

Some Basic Relationships of Probability

• There are some basic probability relationships that can be used to compute
the probability of an event without knowledge of all the sample point
probabilities.
Complement of an Event
Union of Two Events
Intersection of Two Events

Mutually Exclusive Events

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 Statistics for Business and Economics (13e)

Complement of an Event
• The complement of event A is defined to be the event consisting of all
sample points that are not in A.
• The complement of A is denoted by Ac.

Sample
Event A Ac Space S

Venn Diagram

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 Statistics for Business and Economics (13e)

Union of Two Events

• The union of events A and B is the event containing all sample points that
are in A or B or both.
• The union of events A and B is denoted by A  B.

Sample
Event A Event B Space S

Venn Diagram

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 Statistics for Business and Economics (13e)

Union of Two Events

• Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M  C = Markley Oil Profitable
or Collins Mining Profitable (or both)
M  C = {(10, 8), (10, -2), (5, 8), (5, -2), (0, 8), (-20, 8)}
P(M  C) = P(10, 8) + P(10, -2) + P(5, 8) + P(5, -2) + P(0, 8) + P(-20, 8)
= .20 + .08 + .16 + .26 + .10 + .02
= .82

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 Statistics for Business and Economics (13e)

Intersection of Two Events

• The intersection of events A and B is the set of all sample points that are in
both A and B.
• The intersection of events A and B is denoted by A  B.
Intersection of A and B

Sample
Event A Event B Space S

Venn Diagram

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 Statistics for Business and Economics (13e)

Intersection of Two Events

• Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M  C = Markley Oil Profitable and Collins Mining Profitable
M  C = {(10, 8), (5, 8)}
P(M  C) = P(10, 8) + P(5, 8)
= .20 + .16
= .36

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 Statistics for Business and Economics (13e)

Addition Law
• The addition law provides a way to compute the probability of event A, or
B, or both A and B occurring.
• The law is written as:
P(A  B) = P(A) + P(B) - P(A  B)

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 Statistics for Business and Economics (13e)

Addition Law
• Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M  C = Markley Oil Profitable or Collins Mining Profitable
We know: P(M) = .70, P(C) = .48, P(M  C) = .36
Thus: P(M  C) = P(M) + P(C) - P(M  C)
= .70 + .48 - .36
= .82
(This result is the same as that obtained earlier
using the definition of the probability of an event.)

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 Statistics for Business and Economics (13e)

Mutually Exclusive Events

• Two events are said to be mutually exclusive if the events have no sample
points in common.
• Two events are mutually exclusive if, when one event occurs, the other
cannot occur.

Sample
Event A Event B Space S

Venn Diagram

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 Statistics for Business and Economics (13e)

Mutually Exclusive Events

• If events A and B are mutually exclusive, P(A  B) = 0.

• The addition law for mutually exclusive events is:

P(A  B) = P(A) + P(B)

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 Statistics for Business and Economics (13e)

Conditional Probability
• The probability of an event given that another event has occurred is called a
conditional probability.
• The conditional probability of A given B has already occurred is denoted by
P(A|B).
• A conditional probability is computed as follows :
𝑃(𝐴 ∩ 𝐵)
𝑃 𝐴𝐵 =
𝑃(𝐵)

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 Statistics for Business and Economics (13e)

Conditional Probability
• Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
P(C|M) = Collins Mining Profitable given Markley Oil Profitable
We know: P(M  C) = .36, P(M) = .70
𝑃(𝐶∩𝑀) .36
Thus: 𝑃 𝐶 𝑀 = 𝑃(𝑀)
= .70 = .5143

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 Statistics for Business and Economics (13e)

Multiplication Law
• The multiplication law provides a way to compute the probability of the
intersection of two events.
• The law is written as:
P(A  B) = P(B)P(A|B)
or

P(A  B) = P(A)P(B|A)

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 Statistics for Business and Economics (13e)

Multiplication Law
• Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M  C = Markley Oil Profitable and Collins Mining Profitable
We know: P(M) = .70, P(C|M) = .5143
Thus: P(M  C) = P(M)P(M|C)
= (.70)(.5143)
= .36
(This result is the same as that obtained earlier
using the definition of the probability of an event.)

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 Statistics for Business and Economics (13e)

Joint Probability Table

Collins Mining
Markley Oil Profitable (C) Not Profitable (Cc) Total

Profitable (M) .36 .34 .70

Not Profitable (Mc) .12 .18 .30

Total .48 .52 1.00

• Joint probabilities appear in the body of the table.

• Marginal probabilities appear in the margins of the table.

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 Statistics for Business and Economics (13e)

Independent Events
• If the probability of event A is not changed by the existence of event B,
we would say that events A and B are independent.
• Two events A and B are independent if:
P(A|B) = P(A) or P(B|A) = P(B)

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 Statistics for Business and Economics (13e)

Multiplication Law for Independent Events

• The multiplication law also can be used as a test to see if two events are
independent.
• The law is written as:
P(A  B) = P(A)P(B)

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 Statistics for Business and Economics (13e)

Multiplication Law for Independent Events

• Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
Are events M and C independent?
Does P(M  C) = P(M)P(C) ?
We know: P(M  C) = .36, P(M) = .70, P(C) = .48
But: P(M)P(C) = (.70)(.48) = .34, not .36
Hence: M and C are not independent.

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 Statistics for Business and Economics (13e)

Mutual Exclusiveness and Independence

• Do not confuse the notion of mutually exclusive events with that of
independent events.
• Two events with nonzero probabilities cannot be both mutually exclusive
and independent.
• If one mutually exclusive event is known to occur, the other cannot
occur.; thus, the probability of the other event occurring is reduced to
zero (and they are therefore dependent).
• Two events that are not mutually exclusive, might or might not be
independent.

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 Statistics for Business and Economics (13e)

Bayes’ Theorem
• Often we begin probability analysis with initial or prior probabilities.
• Then, from a sample, special report, or a product test we obtain some
additional information.
• Given this information, we calculate revised or posterior probabilities.
• Bayes’ theorem provides the means for revising the prior probabilities.

Application
Prior New Posterior
of Bayes’
Probabilities Information Probabilities
Theorem

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 Statistics for Business and Economics (13e)

Bayes’ Theorem
• Example: L. S. Clothiers
A proposed shopping center will provide strong competition for
downtown businesses like L. S. Clothiers. If the shopping center is built,
the owner of L. S. Clothiers feels it would be best to relocate to the
shopping center.
The shopping center cannot be built unless a zoning change is
approved by the town council. The planning board must first make a
recommendation, for or against the zoning change, to the council.

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 Statistics for Business and Economics (13e)

Prior Probabilities
• Example: L. S. Clothiers
Let:
A1 = town council approves the zoning change
A2 = town council disapproves the change
Using subjective judgment:
P(A1) = .7, P(A2) = .3

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 Statistics for Business and Economics (13e)

New Information
• Example: L. S. Clothiers
The planning board has recommended against the zoning change. Let B
denote the event of a negative recommendation by the planning board.
Given that B has occurred, should L. S. Clothiers revise the probabilities
that the town council will approve or disapprove the zoning change?

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 Statistics for Business and Economics (13e)

Conditional Probabilities
• Example: L. S. Clothiers
Past history with the planning board and the town council indicates
the following:
P(B|A1) = .2 and P(B|A2) = .9
Hence: P(BC|A1) = .8 and P(BC|A2) = .1

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 Statistics for Business and Economics (13e)

Tree Diagram
• Example: L. S. Clothiers
Town Council Planning Board Experimental Outcomes

P(B|A1) = .2
P(A1  B) = .14
P(A1) = .7
c
P(B |A1) = .8 P(A1  Bc) = .56

P(B|A2) = .9
P(A2  B) = .27
P(A2) = .3
c
P(B |A2) = .1 P(A2  Bc) = .03
1.00

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 Statistics for Business and Economics (13e)

Bayes’ Theorem
• To find the posterior probability that event Ai will occur given that event B
has occurred, we apply Bayes’ theorem.
𝑃 𝐴𝑖 𝑃(𝐵|𝐴𝑖 )
𝑃 𝐴𝑖 𝐵 =
𝑃 𝐴1 𝑃 𝐵 𝐴1 + 𝑃 𝐴2 𝑃 𝐵 𝐴2 + ⋯ + 𝑃 𝐴𝑛 𝑃(𝐵|𝐴𝑛 )

• Bayes’ theorem is applicable when the events for which we want to

compute posterior probabilities are mutually exclusive and their union is
the entire sample space.

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 Statistics for Business and Economics (13e)

Posterior Probabilities
• Example: L. S. Clothiers
Given the planning board’s recommendation not to approve the zoning
change, we revise the prior probabilities as follows:
𝑃 𝐴1 𝑃(𝐵|𝐴1 )
𝑃 𝐴1 𝐵 =
𝑃 𝐴1 𝑃 𝐵 𝐴1 + 𝑃 𝐴2 𝑃 𝐵 𝐴2
.7 (.2)
=
.7 .2)+ .3 .9)
= .34

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 Statistics for Business and Economics (13e)

Posterior Probabilities
• Example: L. S. Clothiers
The planning board’s recommendation is good news for L. S. Clothiers.
The posterior probability of the town council approving the zoning change
is .34 compared to a prior probability of .70.

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or 53
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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 1
Prepare the following three columns:
Column 1 - The mutually exclusive events for which posterior probabilities
are desired.
Column 2 - The prior probabilities for the events.
Column 3 - The conditional probabilities of the new information given
each event.

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 1

(1) (2) (3) (4) (5)

Prior Conditional
Events Probabilities Probabilities
Ai P(Ai) P(B|Ai)
A1 .7 .2
A2 .3 .9
1.0

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 2
Prepare the fourth column
Column 4
Compute the joint probabilities for each event and the new
information B by using the multiplication law.
Multiply the prior probabilities in column 2 by the corresponding
conditional probabilities in column 3. That is, P(Ai  B) = P(Ai) P(B|Ai).

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or 56
otherwise on a password-protected website or school-approved learning management system for classroom use.
 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 2

(1) (2) (3) (4) (5)

Prior Conditional Joint
Events Probabilities Probabilities Probabilities
Ai P(Ai) P(B|Ai) P(Ai I B)
A1 .7 .2 .14 = .7(.2)
A2 .3 .9 .27
1.0

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 2 (continued)
We see that there is a .14 probability of the town council approving
the zoning change and a negative recommendation by the planning
board.
There is a .27 probability of the town council disapproving the zoning
change and a negative recommendation by the planning board.

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 3
Sum the joint probabilities in Column 4. The sum is the probability
of the new information, P(B). The sum .14 + .27 shows an overall
probability of .41 of a negative recommendation by the planning
board.

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 3

(1) (2) (3) (4) (5)

Prior Conditional Joint
Events Probabilities Probabilities Probabilities
Ai P(Ai) P(B|Ai) P(Ai I B)
A1 .7 .2 .14
A2 .3 .9 .27
1.0 P(B) = .41

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 4
Prepare the fifth column:
Column 5
Compute the posterior probabilities using the basic relationship of
conditional probability.
𝑃(𝐴𝑖 ∩ 𝐵)
𝑃 𝐴𝑖 𝐵 =
𝑃(𝐵)

The joint probabilities P(Ai I B) are in column 4 and the probability

P(B) is the sum of column 4.

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 Statistics for Business and Economics (13e)

Bayes’ Theorem: Tabular Approach

• Example: L. S. Clothiers
• Step 4

(1) (2) (3) (4) (5)

Prior Conditional Joint Posterior
Events Probabilities Probabilities Probabilities Probabilities
Ai P(Ai) P(B|Ai) P(Ai I B) P(Ai |B)
A1 .7 .2 .14 .3415 = .14/.41
A2 .3 .9 .27 .6585
1.0 P(B) = .41 1.0000

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 Statistics for Business and Economics (13e)

End of Chapter 4

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