CHAPTER ONE

RANDOM VARIABLES AND PROBABILITY DISTRIBUTION

1.1 Introduction
In this chapter we discuss probability distributions of random variables and these are
customary used to model some problems in various fields such as business, finance,
economics and in general life. To clearly understand this chapter, you need some basic
knowledge in probability fundamentals.

1.2 Definition of key Terms

1.2.1 A variable
It is an attribute that can take on different values or characteristics from one individual or
object to another. For example, number of items sold per day varies from one day to another,
then “number of items sold” is a variable.
1.2.2 Random Variable (R.V)
This is a variable whose numerical value is determined by the outcome of a random or
statistical experiment. In other words this is the variable that is subject to randomness and it
can take on different values which make it different from algebraic variable. Random
variables also are normally used in econometrics to determine relationships among one
another. On the other hand, random experiment is an experiment which results into at least
two possible outcomes without a prior knowledge to which one will occur. That is, an
experiment whose outcome cannot be predicted in advance. Most of these statistical
experiments are described in words (e.g. an experiment of tossing a fair coin, asking a
sample of 10 people if they have ever been in the UK, etc), however, at one point in time, the
outcomes from these experiments are described more meaningful in terms of numbers. But
also in real life, most of sample data are in explicated in terms numbers than in words.
Therefore in short random variables are numerical values.

Traditionally random variables are denoted by capital letters, X, Y, Z or X1, X2, X3 etc.

1.2.2.1 Types Of Random Variable

There are two types of random variable (R.V), these are discrete and continuous random
variables. A discrete random variables takes on only a finite number of values and these are
integers. Examples of discrete random variables are; the number of cars passing through the
roadblock, an experiment of tossing one or more fair coins, number of defective items in a
sample, number of death by COVID-19 in year 2020, etc. On the other hand a continuous
random variable is a random variable that can take on any value (always real numbers) in a
given interval of values. Examples of continuous R.V are, height, weight, rainfall,
temperature etc.

General Examples of random variables in the real life are; the unemployment rate,
consumer price index, number of sales made in week, yearly profit of a company, share
prices, return on investments, money supply, GDP, wages, cash flows, interest rates, etc.

1.3 Probability Distribution Of Random Variable

Definition: A probability distribution is a Graph, Table or a function that links each
outcome of a random experiment with its probability of occurrence. In other words we may
say probability distribution is a function that can be used to derive probabilities of each
outcome of a random variable. That is the value taken by this random variable and their
associated probabilities. There are two types of Probability Distribution of a Random
Variable (R.V), these are discrete and continuous Probability Distribution. The following
chart may help you understand the branching of probability distribution

Figure 1: Branches of probability distribution

1.3.1 Discrete Probability Distributions

If a random variable is a discrete variable its probability distributions is called a discrete
probability distribution. With a discrete probability distribution, each possible value of
the discrete random variable can be associated with a non-zero probability. Thus, a discrete
probability distribution can always be presented in Tabular form. The discrete Probability
Distribution is commonly known as Probability Mass Function (PMF). See Figure 1.

1.3.1.1 Probability Mass Function (PMF)

 If X is a discrete random variable, the function denoted by for each
within the range of X is called Probability Mass Function of X. To capture clearly the
meaning of the probability distribution of a discrete random variable consider Example 1.1.

Example 1.1
Consider an experiment of tossing two fair coins simultaneously. Find the probability
distribution of obtaining a total number of heads.

Solution:
The following are the procedures for building probability distribution:

1. list all possible events

2. calculate probability of each event
3. present these probabilities in a suitable table or diagram

The list of all possible events can be obtained easily by using a structure of tree diagram as
shown below:

H
T

Start
H
T

TT

Figure 2: Tree Diagram

From a tree diagram as shown in Figure 2 the list of all possible outcomes of an experiment
(i.e sample space, S) is as shown below:

From the sample space described above, a random variable (i.e. number of heads) takes on
three different values, depending on whether zero head (no head), one head, or two
heads were obtained in the experiment of tossing two fair coins. That is
Probability of an event can be obtained by employing traditional definition of probability,
that is:

n( E )
P( E ) =
n( S )

Let be the number of observed heads. The probabilities of the number of heads showing up
are as indicated below and the probability distribution is shown in Table 1.

Probability Distribution
Number of heads
( )

Total 1.00

Properties of PMF

1. for each
2.
3.

Example 1.2
An employment rate of a certain country A ( ) in percentage is assumed to be a discrete
random variable whose probability distribution is as shown below:
-12 -10 -6 0 4 8 10 12

Prob. 0.10 0.15 0.10 0.15 0.1 0.15 0.1 0.15

Find
 a)
b)

Solution:
a)

c)

1.4 Cumulative Mass Function (CMF)

Definition: Cumulative Mass Function, associated with Probability Mass Function,
of a discrete random variable is defined as follows:

Where means the probability that a random variable takes a value of less than or
equal to a specific value , where is given. For example means the probability that
the random variable takes the value less than of equal to 2.

Example 1.3

Find Probability Mass Function (PMF) and Cumulative Mass Function (CMF) of a total
number of heads obtained by tossing a fair coin three times.

Solution:
The following tree diagram is used to obtain the sample space

H T

H
H
T T
Start

H
T T
H
T

T
Therefore
By letting number of heads shown up, we find that can take values or and
hence the corresponding PMF will be obtained as indicated below:

In Tabula form:
0 1 2 3

It follows that, the Cumulative Mass Function (CMF) will be obtained as indicated here:
From:

However in plotting the CMF the following will be the ranges of :

0 for x0
1
 for 0  x  1
8

4
F ( x) =  for 1 x  2
8
7
8 for 2 x3


1 for 3 x

With reference to the previous example, it can be observed that, a CMF is merely an
accumulation of PMF for the values of less than or equal to a given . That is,
Note: The results for both PMF and CMF can also be summarized in the following Table:
Number of
heads values of PMF values of CMF

0
1
2
3

1.5 Characteristics Of Probability Distribution

Although a probability distribution shows the values taken by a random variable and their
corresponding probabilities, in most cases a researcher might be interested in deducing
some summary characteristics from such probability distribution. These summary
characteristics include among others; the expected value(population mean), variance,
covariance, correlations, etc.

1.5.1 Expected Value of a Discrete Probability Distribution

The average value of a random variable is called the expected value of the random variable,
and this is denoted by E ( X ) .

Definition:
Let be a random variable with probability then the expected value
is given by
or

In other words; if a discrete random variable has possible values with

corresponding probabilities then
expected value is obtained by multiplying the value the random variable takes with the
corresponding probability of occurrence, i.e.

Therefore Σ denotes summation notation whose properties are as indicated below:

Properties of summation notation
1. If is constant, then
 2. If is constant, then

3. It both and are constants, then

Properties of Expected Value

1. The expected value of a constant is equal to the same constant. Hence if is a
constant,

2. The expected value of the sum of two random variables is equal to sum of expected
value of the two random variables. That is for the random variables X and Y.

3. Also

That is, generally, the expected value of the product of two random variables is not
equal to product of the expected values of those random variables. However, there is
an exception to the rule, if X and Y are independent then

4. If is a constant, then

That is to say, the expected value of a constant times a random variable X, is equal to
the constant times the expected value of the R.V
5. If and are constants, then

1.5.2 Variance of a Discrete Probability Distribution

1.5.2.1 Variance and standard deviation
Variance indicates how individual values are spread, dispersed or distributed around the
mean value. But also the statistical concept of variance is a useful measure of risk of any
kind. Generally if X is a discrete random variable, then its variance is given by:

Where
The standard deviation of X is therefore given by

Example 1.4
A company estimates the net profit for a new product to be launched with its corresponding
probabilities under different market conditions as follows;

Market Condition Good Fair Poor

Net Profit (in million Tsh.) 30 10 -3
Probability , 0.15 0.25 0.60

Required:
a) Calculate the expected value of the net profit for the Company
b) What is standard deviation of the net profit

Solution:
a) We know that
n
E ( X ) =  xP( X = x)
i =1

Market Condition Net Profit (in million Tsh) Probability

Good 30 0.15 4.5

Fair 10 0.25 2.5
Poor -3 0.6 -1.8
Total 5.2
Therefore the expected value of the net profit for the company under all three given market
conditions is 5.2 million Tsh.

b) The variance is given by

Market Net Profit (in million Tsh) Probability

Condition

Good 30 0.15 4.5 135

Fair 10 0.25 2.5 25
Poor -3 0.6 -1.8 5.4
Total 5.2 165.4

The Standard Deviation is given by:

Therefore the standard deviation of the net profit for the company under all three given
market conditions is 11.76 million Tsh. This tells us how much the net profit deviates from
the expected value of 5.2 million Tsh. Thus, we may say that although the expected net profit
is about 5.2 million Tsh, it may go above or below this value by 11.76 million Tsh. You may
calculate the confidence interval to estimate the interval on which the expected net profit will
fall.

Example 1.5

A return of certain investment B ( ) in percentage is a discrete random variable whose

probability distribution is as shown below:
-10 -6 0 4 8 12

Prob. 0.15 0.2 0.15 0.1 0.15 0.25

Find the expected value and the standard deviation of

Solution
Let be a return of investment. For the purpose of simplification, we can summarise the
sums as indicated in the Table below:

-10 0.15 -1.5 15

-6 0.2 -1.2 7.2
0 0.15 0 0
4 0.1 0.4 1.6
8 0.15 1.2 9.6
12 0.25 3 36
TOTAL 1.9 69.4
Hence:

Example 1.6

A monthly income of workers in millions of TShs from a certain sector with their associated
probabilities are as indicated in the following probability distribution

Income 1.4 3.5 2.0 0.9 3.0

Probability 0.25 0.2 0.15 0.1 0.3

Find the expected income and standard deviation of all workers

Solution:
Let be a monthly income of worker. For the purpose of simplification, we can summarise
the sums as indicated in the Table below:

1.4 0.25 0.35 0.49

3.5 0.2 0.7 2.45
2 0.15 0.3 0.6
0.9 0.1 0.09 0.081
3 0.3 0.9 2.7
TOTAL 2.34 6.321
Hence:

Properties of variance

1. The variance of a constant is zero. That is to say, if is a constant, then

2. If X and Y are two independent random variables, then

and

3. If is a constant, then

4. If is a constant, then

5. If X and Y are independent random variables and and are constants, then