Module 4 Probability: An introduction to modeling
uncertainty (Part 1)
Lecturer: Dr Wendy Shi
Maritime and Logistics Management
F96, Swanson Building
[email protected]
Key topics in this module
• Events and probabilities
• Basic relationships of probability
• Conditional probability
• Random variables
Uncertainty
Uncertainty and probability
• 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.
In many business scenarios, data are available to provide information on possible outcomes for some
decisions, but the exact outcome from a given decision is almost never known with certainty because
many factors are outside the control of the decision maker (e.g., actions taken by competitors, the
weather).
• Probability is the numerical measure of the likelihood that an event will occur.
This measure of uncertainty is often communicated through a probability distribution.
It can provide additional information about an event and help a decision maker evaluate possible
actions and determine best course of action.
Events and probabilities
Random experiment
• A random experiment is a process that generates well-defined outcomes.
Sample space: all possible outcomes
Event: a collection of outcomes
Probability of an event: it is equal to the sum of probabilities of outcomes for the event.
• Example: rolling a die
Possible outcomes are defined as “the number of dots showing on the upward face of the die”.
Sample space; Events: A= the observed number is smaller than 3; Probability: P(A)? P(B)?
B= the observed number is greater than 4
Relationships of probability
Completion of an event
• The complement of an event A (AC) is defined to be the event consisting of all outcomes
that are not in A.
• Venn diagram
Rectangular area: the sample space for the random experiment and contains all possible outcomes.
Circle: event A and contains only the outcomes that belong to A
Shaded region: it contains all outcomes not in event A.
Relationships of probability
• P(A) can be computed easily if the probability of its complement is known.
Addition law
• Applicability: The addition law is helpful when we are interested in knowing the
probability that at least one of two events will occur. It is related to the combination of
events (i.e., union, intersection).
• Union of events ( A B. ): The event containing all outcomes belonging to A or B or both.
Relationships of probability
• Intersection of events ( A B.): it contains the outcomes that belong to both A and B.
Area in which the two circles overlap is the intersection. It contains outcomes that are in both A and B.
• Mutually exclusive events
If the occurrence of one event precludes the occurrence of the other.
If the events have no outcomes in common
Conditional probability
Conditional probability
• When the probability of one event (A) is dependent on whether some related event (B)
has already occurred. It is written P(A|B).
The notation | indicates that we are considering the probability of event A given the condition that event
B has occurred. Hence, the notation P(A|B) reads “the probability of A given B.”
• 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
• Crosstabulation
Conditional probability
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
Question: Is this probability different
for married customers as compared
with single customers?
Conditional probability
What is the probability that a randomly selected customer does not default on his or her mortgage and
the customer is married? P(M∩D)=79/300=0.2633 .
P(M∩DC)=64/300=0.2133 is the probability that a randomly selected customer is married, and that the
customer does not default on his or her mortgage.
P(S∩D)=41/300=0.1367 is the probability that a randomly selected customer is single and that the
customer defaults on his or her mortgage.
P(S∩DC)=116/300=0.3867 is the probability that a randomly selected customer is single and that the
customer does not default on his or her mortgage.
Conditional probability
• Joint probabilities: When values give the probability of the intersection of two events
• Marginal probabilities: They 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.
P(D|M)=P(D∩M)/P(M)=0.2633/0.4766=0.5524; Note also that the conditional probability P(D|M) can be
computed as the ratio of the joint probability P(D∩M) to the marginal probability P(M).
Conditional probability
• Excel PivotTable to calculate conditional probabilities
We can calculate these conditional probabilities by right-clicking on any numerical value in the body of
the PivotTable and then selecting Show Values As and choosing % of Row Total.
Conditional probability
• 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.
• Multiplication law
To calculate the probability of the intersection of two events.
Conditional probability
• Bayes’ theorem
Logic: 1) begin the analysis with initial or prior probability estimates for specific events. 2) obtain
additional information about events. 3) given new information, update the prior probability values by
calculating revised probabilities, referred to as posterior probabilities.
Example: consider a manufacturing firm that receives shipments of parts from two different suppliers.
A1=the event that the part is from supplier 1; A2=the event that a part is from supplier 2.
G=the event that a part is good; B=the event that a part is bad.
Prior probabilities: P(A1)=0.65; P(A2)=0.35
The quality (G, B) of the purchased parts varies according to their source.
Question: 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?
Conditional probability
Conditional probability
• 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
Random variable
• It is a numerical description of the outcome of a random experiment. They are quantities
whose values are not known with certainty.
Discrete random variable (DRV): it can take on only specified discrete values.
Continuous random variable (CRV): it may assume any numerical value in an interval or collection of
intervals (e.g., time, weight, distance, and temperature).
Many DRVs have a large number of potential outcomes and so can be effectively modeled as CRVs.
Discrete probability distributions
Thanks for your attention!
