Probability: An Introduction
to Modeling Uncertainty
Chapter 5
Introduction
• Uncertainty is an ever-present fact of life for decision makers.
• Much time and effort are spent trying to plan for and respond to
uncertainty.
• Probability is the numerical measure of the likelihood that an event
will occur.
• This measure of uncertainty is often communicated through a
probability distribution:
• Extremely helpful in providing additional information about an event.
• Can be used to help a decision maker evaluate possible actions and
determine best course of action.
Events and Probabilities
Events and Probabilities (Slide 1 of 6)
• A random experiment is a process that generates well-defined
outcomes.
• By specifying all possible outcomes, we identify the sample space for
a random experiment; examples:
• A coin toss.
• Rolling a die.
• An event is defined as a collection of outcomes.
Events and Probabilities (Slide 2 of 6)
Table 5.1: Random Experiments and Experimental Outcomes
Random Experiment Experimental Outcomes
Toss a coin Head, tail
Roll a die 1, 2, 3, 4, 5, 6
Conduct a sales call Purchase, no purchase
Hold a particular share of stock for one year Price of stock goes up, price of stock goes down,
no change in stock price
Reduce price of product Demand goes up, demand goes down, no change
in demand
Events and Probabilities (Slide 3 of 6)
• Example: California Power & Light Company (CP&L).
• CP&L is starting a project designed to increase the generating capacity
of one of its plants in southern California.
• Analysis of similar construction projects indicates that the possible
completion times for the project are 8, 9, 10, 11, and 12 months.
Events and Probabilities (Slide 4 of 6)
Table 5.2: Completion Times for 40 CP&L Projects
Events and Probabilities (Slide 5 of 6)
• The probability of an event is equal to the sum of probabilities of
outcomes for the event.
• CP&L example: Letting C denote the event that the project is
completed in 10 months or less.
• The probability of event C, denoted P C , is given by:
P(C ) P(8) P(9) P(10) 0.15 0.25 0.30 0.70
• We can tell CP&L management that there is a 0.70 probability that
the project will be completed in 10 months or less.
Some Basic Relationships of
Probability
Complement of an Event
Addition Law
Some Basic Relationships of Probability
(Slide 1 of 11)
Completion of an Event:
• Given an event A, the complement of A is defined to be the event consisting
of all outcomes that are not in A.
• Figure 5.1 shows what is known as a Venn diagram, which illustrates the
concept of a complement:
• Rectangular area represents the sample space for the random experiment and
contains all possible outcomes.
• Circle represents event A and contains only the outcomes that belong to A.
• Shaded region of the rectangle contains all outcomes not in event A.
Some Basic Relationships of Probability
(Slide 2 of 11)
Figure 5.1: Venn Diagram for Event A
Some Basic Relationships of Probability
(Slide 3 of 11)
C
• In any probability application, either event A or its complement A
must occur.
• Solving for P(A) , we obtain the following result:
• The probability of an event A can be computed easily if the
probability of its complement is known.
Some Basic Relationships of Probability
(Slide 4 of 11)
Addition Law:
• The addition law is helpful when we are interested in knowing the
probability that at least one of two events will occur.
• Concepts related to the combination of events:
• The union of events.
• The intersection of events.
Some Basic Relationships of Probability
(Slide 5 of 11)
• Given two events A and B, the union of A and B is defined as the
event containing all outcomes belonging to A or B or both.
• The union of A and B is denoted by A B.
• The Venn diagram in Figure 5.2 depicts the union of A and B:
• One circle contains all the outcomes of A.
• The other circle contains all the outcomes of B.
Some Basic Relationships of Probability
(Slide 6 of 11)
Figure 5.2: Venn Diagram for the Union of Events A and B
Some Basic Relationships of Probability
(Slide 7 of 11)
• The definition of the intersection of A and B is the event containing
the outcomes that belong to both A and B.
• The intersection of A and B is denoted by A B.
• The Venn diagram depicting the intersection of A and B is shown in
Figure 5.3:
• The area in which the two circles overlap is the intersection.
• It contains outcomes that are in both A and B.
Some Basic Relationships of Probability
(Slide 8 of 11)
Figure 5.3: Venn Diagram for the Intersection of Events A and B
Some Basic Relationships of Probability
(Slide 9 of 11)
• The addition law provides a way to compute the probability that event A or event
B or both will occur.
• Used to compute the probability of the union of two events.
• A special case arises for mutually exclusive events:
• If the occurrence of one event precludes the occurrence of the other.
• If the events have no outcomes in common.
Some Basic Relationships of Probability
(Slide 10 of 11)
Figure 5.4: Venn Diagram for Mutually Exclusive Events
Some Basic Relationships of Probability
(Slide 11 of 11)
Conditional Probability
Independent Events
Multiplication Law
Bayes’ Theorem
Conditional Probability (Slide 1 of 21)
• Conditional probability: When the probability of one event is
dependent on whether some related event has already occurred.
• Illustration: Lancaster Savings and Loan:
• Interested in mortgage default risk.
• Interested in whether the probability of a customer defaulting differs by
marital status.
Conditional Probability (Slide 2 of 21)
Table 5.3: Subset of Data from 300 Home Mortgages of Customers at
Lancaster Savings and Loan
Customer Marital Annual Mortgage Payments Total Default on
No. Age Status Income Amount per Year Amount Paid Mortgage?
1 37 Single $172,125.70 $473,402.96 24 $581,885.13 Yes
2 31 Single $108,571.04 $300,468.60 12 $489,320.38 No
3 37 Married $124,136.41 $330,664.24 24 $493,541.93 Yes
4 24 Married $79,614.04 $230,222.94 24 $449,682.09 Yes
5 27 Single $68,087.33 $282,203.53 12 $520,581.82 No
6 30 Married $59,959.80 $251,242.70 24 $356,711.58 Yes
Conditional Probability (Slide 3 of 21)
Table 5.3: Continued
Customer Marital Annual Mortgage Payments Total Amount Default on
No. Age Status Income Amount per Year Paid Mortgage?
7 41 Single $99,394.05 $282,737.29 12 $524,053.46 No
8 29 Single $38,527.35 $238,125.19 12 $468,595.99 No
9 31 Married $112,078.62 $297,133.24 24 $399,617.40 Yes
10 36 Single $224,899.71 $622,578.74 12 $1,233,002.14 No
11 31 Married $27,945.36 $215,440.31 24 $285,900.10 Yes
12 40 Single $48,929.74 $252,885.10 12 $336,574.63 No
13 39 Married $82,810.92 $183,045.16 12 $262,537.23 No
Conditional Probability (Slide 4 of 21)
Table 5.3: Continued
Customer Marital Annual Mortgage Payments Total Default on
No. Age Status Income Amount per Year Amount Paid Mortgage?
14 31 Single $68,216.88 $165,309.34 12 $253,633.17 No
15 40 Single $59,141.13 $220,176.18 12 $424,749.80 No
16 45 Married $72,568.89 $233,146.91 12 $356,363.93 No
17 32 Married $101,140.43 $245,360.02 24 $388,429.41 Yes
18 37 Married $124,876.53 $320,401.04 4 $360,783.45 Yes
19 32 Married $133,093.15 $494,395.63 12 $861,874.67 No
20 32 Single $85,268.67 $159,010.33 12 $308,656.11 No
Conditional Probability (Slide 5 of 21)
Table 5.3: Continued
Customer Marital Annual Mortgage Payments Total Default on
No. Age Status Income Amount per Year Amount Paid Mortgage?
21 37 Single $92,314.96 $249,547.14 24 $342,339.27 Yes
22 29 Married $120,876.13 $308,618.37 12 $472,668.98 No
23 24 Single $86,294.13 $258,321.78 24 $380,347.56 Yes
24 32 Married $216,748.68 $634,609.61 24 $915,640.13 Yes
25 44 Single $46,389,75 $194,770.91 12 $385,288.86 No
Conditional Probability (Slide 6 of 21)
Table 5.4: Crosstabulation of Marital Status and if Customer Defaults on
Mortgage
Marital Status No Default Default Total
Married 64 79 143
Single 116 41 157
Total 180 120 300
• From Table 5.4 or Figure 5.5, the probability that a customer defaults on his or
her mortgage is 120 300 0.4.
• The probability that a customer does not default on his or her mortgage is
1 0.4 0.6 or 180 300.
Conditional Probability (Slide 7 of 21)
Figure 5.5: PivotTable for Marital Status and Whether Customer Defaults on Mortgage
Conditional Probability (Slide 8 of 21)
• When values give the probability of the intersection of two events, the
probabilities are called joint probabilities.
• Marginal probabilities are found by summing the joint probabilities in the
corresponding row or column of the joint probability table.
• Conditional probabilities can be computed as the ratio of joint probability to a
marginal probability.
Conditional Probability (Slide 9 of 21)
Table 5.5: Joint Probability Table for Customer Mortgage Prepayments
Conditional Probability (Slide 10 of 21)
Figure 5.6: Using Excel PivotTable to Calculate Conditional Probabilities
Conditional Probability (Slide 11 of 21)
Independent Events:
• If the probability of event D is not changed by the existence of event
M, then we would say that events D and M are independent events.
• Otherwise, the events are dependent.
Conditional Probability (Slide 12 of 21)
Multiplication Law:
• Multiplication law can be used to calculate the probability of the
intersection of two events.
• Based on the definition of conditional probability.
Conditional Probability (Slide 13 of 21)
• Special case in which events A and B are independent.
• To compute the probability of the intersection of two independent
events, simply multiply the probabilities of each event.
Conditional Probability (Slide 14 of 21)
Bayes’ Theorem:
• Often begin the analysis with initial or prior probability estimates for
specific events of interest.
• Then, obtain additional information about events.
• Given new information, update the prior probability values by
calculating revised probabilities, referred to as posterior
probabilities.
• Bayes’ theorem provides a means for making these probability
calculations.
Conditional Probability (Slide 15 of 21)
• Example: A manufacturing firm receives shipments of parts from two
different suppliers:
• 65% of the parts purchased from supplier 1.
• 35% of the parts purchased from supplier 2.
• Quality of purchased parts varies according to their source.
Conditional Probability (Slide 16 of 21)
Table 5.6: Historical Quality Levels for Two Suppliers
• Historical data suggest the quality ratings of the two suppliers:
% Good Parts % Bad Parts
Supplier 1 98 2
Supplier 2 95 5
• Figure 5.7 shows a diagram that depicts the process of the firm
receiving a part from one of the suppliers and then discovering that
the part is good or bad as a two-step random experiment.
Conditional Probability (Slide 17 of 21)
Figure 5.7: Diagram for Two-Supplier Example
Step 1 shows that the
part comes from one of
two suppliers and Step 2
shows whether the part
is good or bad.
Conditional Probability (Slide 18 of 21)
• The process of computing joint probabilities can be depicted in what
is called a probability tree.
• From left to right through the tree:
• The probabilities for each branch at step 1 are prior probabilities.
• The probabilities for each branch at step 2 are conditional probabilities.
• To find the probability of each experimental outcome, multiply the
probabilities on the branches leading to the outcome.
Conditional Probability (Slide 19 of 21)
Figure 5.8: Probability Tree for Two-Supplier Example
Conditional Probability (Slide 20 of 21)
• Suppose the parts from the two suppliers are used in the firm’s manufacturing
process and a machine breaks while attempting the process using a bad part:
• Given the information that the part is bad, what is the probability that it came from
supplier 1 and what is the probability that it came from supplier 2?
• With the information in the probability tree, Bayes’ theorem can be used to answer
these questions.
Conditional Probability (Slide 21 of 21)
• Bayes’ theorem is applicable when events for which we want to
compute posterior probabilities are mutually exclusive and their
union is the entire sample space.
Random Variables
Discrete Random Variables
Continuous Random Variables
Random Variables (Slide 1 of 6)
• Random variables are quantities whose values are not known with
certainty.
• In probability terms, a random variable is a numerical description of
the outcome of a random experiment.
• A random variable can be classified as being either:
• Discrete.
• Continuous.
Random Variables (Slide 2 of 6)
Discrete Random Variables:
• A random variable that can take on only specified discrete values is
referred to as a discrete random variable.
• Table 5.7 provides examples of discrete random variables.
• Table 5.8 repeats the joint probability table for the Lancaster Savings
and Loan data, but with the values labeled as random variables.
Random Variables (Slide 3 of 6)
Table 5.7: Examples of Discrete Random Variables
Possible Values for the Random
Random Experiment Random Variable (x) Variable
Flip a coin Face of a coin showing 1 if heads; 0 if tails
Roll a die Number of dots showing on top of 1, 2, 3, 4, 5, 6
die
Contact five customers Number of customers who place an 0, 1, 2, 3, 4, 5
order
Operate a health care clinic for one Number of patients who arrive 0, 1, 2, 3, …
day
Offer a customer the choice of two Product chosen by customer 0 if none; 1 if choose product A; 2 if
products choose product B
Random Variables (Slide 4 of 6)
Table 5.8: Joint Probability Table for Customer Mortgage Prepayments
Random Variables (Slide 5 of 6)
Continuous Random Variables:
• A random variable that may assume any numerical value in an
interval or collection of intervals is called a continuous random
variable.
• Technically, relatively few random variables are truly continuous;
examples are values related to time, weight, distance, and
temperature.
• Many discrete random variables have a large number of potential
outcomes and so can be effectively modeled as continuous random
variables.
Random Variables (Slide 6 of 6)
Table 5.9: Examples of Continuous Random Variables
Discrete Probability Distributions
Custom Discrete Probability Distribution
Expected Value and Variance
Discrete Uniform Probability Distribution
Binomial Probability Distribution
Poisson Probability Distribution
Discrete Probability Distributions (Slide 1 of 21)
• The probability distribution for a random variable describes the
range and relative likelihood of possible values for a random variable.
• For a discrete random variable x, the probability distribution is
defined by the probability mass function, denoted by f (x).
• The probability mass function provides the probability for each value
of the random variable.
• We can present probability distributions graphically.
Discrete Probability Distributions (Slide 2 of 21)
Figure 5.9: Graphical Representation of the Probability Distribution for
Whether a Customer Defaults on a Mortgage
Discrete Probability Distributions (Slide 3 of 21)
Custom Discrete Probability Distribution:
• A probability that is generated from observations is called an
empirical probability distribution.
• An empirical probability is considered a custom discrete probability
distribution if it is discrete and the possible values of the random
variable have different values:
• Useful for describing different possible scenarios that have different
probabilities.
• Probabilities generated using either the subjective method or the
relative frequency method.
Discrete Probability Distributions (Slide 4 of 21)
Table 5.10: Summary Table of Number of Payments Made per Year
• Example: The random variable describing the number of mortgage
payments made per year by randomly chosen customers.
Discrete Probability Distributions (Slide 5 of 21)
Figure 5.10: Excel PivotTable for Number of Payments Made per Year
Discrete Probability Distributions (Slide 6 of 21)
Expected Value and Variance:
• The expected value, or mean, of a random variable is a measure of
the central location for the random variable.
Discrete Probability Distributions (Slide 7 of 21)
Table 5.11: Calculation of the Expected Value for Number of Payments
Made per Year by a Lancaster Savings and Loan Mortgage Customer
• If Lancaster Savings and Loan signs a new mortgage customer, the
expected number of payments per year for this customer is 13.8.
Discrete Probability Distributions (Slide 8 of 21)
Figure 5.11: Using Excel SUMPRODUCT Function to Calculate the
Expected Value for Number of Payments Made per Year by a Lancaster
Savings and Loan Mortgage Customer
Discrete Probability Distributions (Slide 9 of 21)
Figure 5.12: Excel Calculation of the Expected Value for Number of
Payments Made per Year by a Lancaster Savings and Loan Mortgage
Customer
Discrete Probability Distributions (Slide 10 of 21)
• Variance is a measure of variability:
• An essential part of the variance formula is the deviation, x ,
which measures how far a particular value of the random variable is
from the expected value, or mean, .
Discrete Probability Distributions (Slide 11 of 21)
Table 5.12: Calculation of the Variance for Number of Payments Made
per Year by a Lancaster Savings and Loan Mortgage Customer
• The standard deviation, , is defined as the positive square root of the
variance.
• The standard deviation for the payments made per year by a mortgage
customer is 42.360 6.508.
Discrete Probability Distributions (Slide 12 of 21)
Figure 5.13: Excel Calculation of the Variance for Number of Payments
Made per Year by a Lancaster Savings and Loan Mortgage Customer
Discrete Probability Distributions (Slide 13 of 21)
Discrete Uniform Probability Distribution:
• When the possible values of the probability mass function are all
equal, then the probability distribution is a discrete uniform
probability distribution.
• Where n = the number of unique values that may be assumed by the
random variable.
Discrete Probability Distributions (Slide 14 of 21)
Binomial Probability Distribution:
• A binomial probability distribution is a discrete probability
distribution that can be used to describe many situations in which a
fixed number (n) of repeated identical and independent trials has
two, and only two, possible outcomes:
• Success.
• Failure.
Discrete Probability Distributions (Slide 15 of 21)
• The probability mass function for a binomial random variable that
calculates the probability of x successes in n independent events.
Discrete Probability Distributions (Slide 16 of 21)
Table 5.13: Probability Distribution for the Number of Customers Who
Click on the Link in the Martin’s Targeted E-Mail
• Example: Martin’s, an online specialty clothing store, sends out
targeted e-mails to its best customers notifying them about special
discounts available only to the recipients.
Discrete Probability Distributions (Slide 17 of 21)
Figure 5.14: Graphical Representation of the Probability Distribution for
the Number of Customers Who Click on the Link in the Martin’s
Targeted E-Mail
Discrete Probability Distributions (Slide 18 of 21)
Figure 5.15: Excel Worksheet for Computing Binomial Probabilities of
the Number of Customers Who Make a Purchase at Martin’s
Discrete Probability Distributions (Slide 19 of 21)
Poisson Probability Distribution:
• A discrete random variable that is often useful in estimating the
number of occurrences of an event over a specified interval of time
and space.
• Examples:
• Number of patients who arrive at a health care clinic in one hour.
• Number of computer-server failures in a month.
• Number of repairs needed in 10 miles of highway.
• Number of leaks in 100 miles of pipeline.
Discrete Probability Distributions (Slide 20 of 21)
• If the following two properties are satisfied, the number of occurrences is a
random variable described by the Poisson probability distribution:
• The probability of an occurrence is the same for any two intervals (of time or space)
of equal length.
• The occurrence or nonoccurrence in any interval (of time or space) is independent of
the occurrence or nonoccurrence in any other interval.
Discrete Probability Distributions (Slide 21 of 21)
Figure 5.16: Excel Worksheet for Computing Poisson Probabilities of the
Number of Patients Arriving at the Emergency Room
Continuous Probability
Distributions
Uniform Probability Distribution
Triangular Probability Distribution
Normal Probability Distribution
Exponential Probability Distribution
Continuous Probability Distributions (Slide 1 of 30)
• Fundamental difference separates discrete and continuous random
variables in terms of how probabilities are computed:
• Discrete random variables – the probability mass function f (x) provides the
probability that the random variable assumes a particular value.
• Continuous random variables – the counterpart of the probability mass
function is the probability density function, also denoted by f (x).
• The probability density function does not directly provide probabilities.
• We are computing the probability that the random variable assumes any
value in an interval.
• For continuous random variables, the probability of any particular value
of the random variable is zero.
Continuous Probability Distributions (Slide 2 of 30)
Uniform Probability Distribution:
• Example: Random variable x representing the flight time of an
airplane traveling from Chicago to New York.
• With every interval of a given length being equally likely, the random
variable x is said to have a uniform probability distribution.
Continuous Probability Distributions (Slide 3 of 30)
Figure 5.17: Uniform Probability Distribution for Flight Time
Continuous Probability Distributions (Slide 4 of 30)
Figure 5.18: The Area Under the Graph Provides the Probability of a
Flight Time Between 120 and 130 Minutes
Continuous Probability Distributions (Slide 5 of 30)
• The calculation of the expected value and variance for a continuous
random variable is analogous to that for a discrete random variable.
• For uniform continuous probability distribution, the formulas for the
expected value and variance are:
b a
2
ab
E (x) Var(x)
2 12
Continuous Probability Distributions (Slide 6 of 30)
Triangular Probability Distribution:
• Useful only when subjective probability estimates are available.
• In the triangular probability distribution, we need only specify:
• The minimum possible value a.
• The maximum possible value b.
• The most likely value (or mode) of the distribution m.
• If these values can be knowledgeably estimated, then as an
approximation of the actual probability density function, we can
assume that the triangular distribution applies.
Continuous Probability Distributions (Slide 7 of 30)
Figure 5.19: Triangular Probability Distribution for Time Required for
Initial Assessment of Corporate Headquarters Construction
Continuous Probability Distributions (Slide 8 of 30)
• Note in Figure 5.19 that the probability density function is a triangular
shape.
• The general form of the triangular probability density function is:
Continuous Probability Distributions (Slide 9 of 30)
• The geometry required to find the area under the graph for any given
value is slightly more complex than that required to find the area for a
uniform distribution.
Continuous Probability Distributions (Slide 10 of 30)
Figure 5.20: Triangular Distribution to Determine
P 10 x 18 P x 18 P x 10
Continuous Probability Distributions (Slide 11 of 30)
Normal Probability Distribution:
• One of the most useful probability distributions for describing a continuous
random variable is the normal probability distribution.
• Wide variety of practical and business applications:
• Heights and weights of people.
• Test scores.
• Scientific measurements.
• Uncertain quantities such as demand for products.
• Rate of return for stocks and bonds.
• Time it takes to manufacture a part or complete an activity.
Continuous Probability Distributions (Slide 12 of 30)
Figure 5.21: Bell-Shaped Curve for the Normal Distribution
Continuous Probability Distributions (Slide 13 of 30)
• The probability density function that defines the bell-shaped curve of
the normal distribution is:
Continuous Probability Distributions (Slide 14 of 30)
Characteristics of the normal distribution:
1. The entire family of normal distributions is differentiated by two
parameters: the mean and the standard deviation .
2. The highest point on the normal curve is at the mean, which is also
the median and mode of the distribution.
3. The mean of the distribution can be any numerical value: negative,
zero, or positive (see Figure 5.22).
Continuous Probability Distributions (Slide 15 of 30)
Figure 5.22: Three Normal Distributions with the Same Standard
Deviation but Different Means ( 10, 0, 20)
Continuous Probability Distributions (Slide 16 of 30)
Characteristics of the normal distribution (continued):
4. The normal distribution is symmetric, with the shape of the normal
curve to the left of the mean a mirror image of the shape of the
normal curve to the right of the mean.
5. The tails of the curve extend to infinity in both directions and
theoretically never touch the horizontal axis.
6. The standard deviation determines how flat and wide the normal
curve is; larger values of the standard deviation result in wider, flatter
curves, showing more variability in the data (see Figure 5.23).
Continuous Probability Distributions (Slide 17 of 30)
Figure 5.23: Two Normal Distributions with the Same Mean but
Different Standard Deviations ( 5, 10)
Continuous Probability Distributions (Slide 18 of 30)
Characteristics of the normal distribution (continued):
7. The mean of the distribution can be any numerical value: negative,
zero, or positive.
8. The percentages of values in some commonly used intervals are:
a. 68.3% of the values of a normal random variable are within plus or
minus one standard deviation of its mean.
b. 95.4% of the values of a normal random variable are within plus or
minus two standard deviations of its mean.
c. 99.7% of the values of a normal random variable are within plus or
minus three standard deviations of its mean.
Continuous Probability Distributions (Slide 19 of 30)
Figure 5.24: Areas Under the Curve for Any Normal Distribution
Continuous Probability Distributions (Slide 20 of 30)
• Application of the normal probability distribution: Grear Aircraft Engines
sells aircraft engines to commercial airlines.
• Grear offers performance-based sales contract guaranteeing that engines
will provide certain amount of lifetime flight hours subject to airline
purchasing a preventive-maintenance service plan.
• Based on extensive flight testing and computer simulations, Grear believes
mean lifetime flight hours is normally distributed with a mean 36,500
hours and standard deviation 5,000 hours.
• What is the probability that an engine will last more than 40,000 hours?
Continuous Probability Distributions (Slide 21 of 30)
Figure 5.25: Grear Aircraft Engines Lifetime Flight Hours Distribution
Continuous Probability Distributions (Slide 22 of 30)
Figure 5.26: Excel Calculations for Grear Aircraft Engines Example
Continuous Probability Distributions (Slide 23 of 30)
• Grear is considering a guarantee that will provide a discount on a
replacement aircraft engine if the original engine does not meet the
lifetime-flight-hour guarantee.
• How many lifetime flight hours should Grear guarantee if Grear wants
no more than 10% of aircraft engines to be eligible for the discount
guarantee? (See Figure 5.27.)
• How do we calculate the probability that an engine will have a
lifetime of flight hours greater than 30,000 but less than 40,000
hours? (See Figures 5.28 and 5.29.)
Continuous Probability Distributions (Slide 24 of 30)
Figure 5.27: Grear’s Discount Guarantee
Continuous Probability Distributions (Slide 25 of 30)
Figure 5.28: Graph Showing the Area Under the Curve Corresponding
to P 30,000 x 40,000 in the Grear Aircraft Engines Example
Continuous Probability Distributions (Slide 26 of 30)
Figure 5.29: Using Excel to Find P 30,000 x 40,000 in the Grear
Aircraft Engines Example
Continuous Probability Distributions (Slide 27 of 30)
Exponential Probability Distribution:
• The exponential probability distribution may be used for random variables such as:
• Time between patient arrivals at an emergency room.
• Distance between major defects in a highway.
• Time until default in certain credit-risk models.
Continuous Probability Distributions (Slide 28 of 30)
• Example: x represents time between business loan defaults for a
particular lending agency.
• If the mean time between loan defaults is 15 months, the graph of
the probability is shown in Figure 5.30.
• To compute exponential probabilities, we use:
• Figure 5.31 shows how to calculate these values for an exponential
distribution in Excel using EXPON.DIST.
Continuous Probability Distributions (Slide 29 of 30)
Figure 5.30: Exponential Distribution for the Time Between Business
Loan Defaults Example
Continuous Probability Distributions (Slide 30 of 30)
Figure 5.31: Using Excel to Calculate P 6 x 18 for the Time Between
Business Loan Defaults Example
