Business Analytics: Methods, Models,

and Decisions
Third Edition

Chapter 5
Probability
Distributions and
Data Modeling

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Basic Concepts of Probability
• Probability is the likelihood that an outcome
occurs. Probabilities are expressed as values
between 0 and 1.
• An experiment is the process that results in an
outcome.
• The outcome of an experiment is a result that
we observe.
• The sample space is the collection of all
possible outcomes of an experiment.
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Combinations and Permutations

• Enumerating and counting the outcomes for an

experiment can sometimes be difficult,
particularly when the experiment consists of
multiple steps.
• A bit of logic and visualization often helps.

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Example 5.1: Rolling Two Dice
• Tree diagram
• For an experiment with
k steps, the number of
outcomes is

For rolling two dice, we have

6 outcomes for the first roll,
and 6 outcomes for the
second roll. The total number
of outcomes is 6 x 6 = 36.

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Example 5.2: Selecting n Objects
from N

• In a group of five students, an instructor might

wish to select three of them to make
presentations.
• The first student selected can be student 1, 2, 3,
4, or 5. However, if student 1 is selected first,
then the second student can be 2, 3, 4, or 5.
Then, if the second student selected is student 4,
the third student can be 2, 3, or 5.

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Combinations

• When the order does not matter, we only want

to count unique outcomes, which we call
combinations.
• The number of combinations for selecting
n objects from a set of N is

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Example 5.3: Applying the
Combinations Formula

• In Example 5.2, the number of ways of selecting

three students from a group of five is

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Permutations

• If we want to select n objects from N and the

order is important, then we call the outcomes
permutations.
• The number of permutations of n objects
selected from N is

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Example 5.4: Applying the
Permutations Formula

• Suppose we want to count the number of ways

of selecting three students from a group of five
where the order is important (for instance,
knowing which student presents first, second,
and third).

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Probability Definitions
Probabilities may be defined from one of three
perspectives:
• Classical definition: probabilities can be deduced
from theoretical arguments
• Relative frequency definition: probabilities are
based on empirical data
• Subjective definition: probabilities are based on
judgment and experience

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Example 5.5 Classical Definition of
Probability
Roll 2 dice Die Sum Frequency

• 36 possible rolls 2 1
3 2
• Probability = number of ways of 4 3
rolling a number divided by 36; 5 4
6 5
e.g., probability of a 3 is 2/36 = 1/18 7 6

Suppose two consumers try a new product. 8 5

9 4
• Four outcomes: 10 3

1. like, like 11 2
12 1
2. like, dislike
Sum 36
3. dislike, like
4. dislike, dislike
• Probability at least one dislikes product
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Example 5.6: Relative Frequency
Definition of Probability
• Use relative frequencies as probabilities.
• Probability a computer is repaired in 10 days = 0.076

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Probability Rules and Formulas
• Label the n outcomes in a sample space as
where represents the ith outcome in the sample space. Let
be the probability associated with the outcome

• The probability associated with any outcome must be

between 0 and 1.

• The sum of the probabilities over all possible outcomes

must be equal to 1.

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Probabilities Associated with Events
• An event is a collection of one or more outcomes
from a sample space.
• Rule 1. The probability of any event is the sum of
the probabilities of the outcomes that comprise that
event.

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Example 5.7: Computing the
Probability of an Event
Die Sum Frequency

Consider the events:

2 1
3 2

• Rolling 7 or 11 on two dice 4

5
3
4
6 5
Probability 7 6
8 5
9 4

• Repair a computer in 7 days or less 10

11
3
2

Probability = 12
Sum
1
36

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Complement of an Event
• If A is any event, the complement of A, denoted
consists of all outcomes in the sample space
not in A.
• Rule 2. The probability of the complement of any
event A is

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Example 5.8: Computing the Probability
of the Complement of an Event
Dice Example: Die Sum Frequency
2 1

• 3
4
2
3
5 4
6 5
7 6
8 5
9 4
• 10 3
11 2

• Using Rule 2: 12
Sum
1
36

P(Ac) = 1 – 8/36 = 28/36

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Union of Events
• The union of two events contains all outcomes that
belong to either of the two events.
– If A and B are two events, the probability that some
outcome in either A or B (that is, the union of A and B)
occurs is denoted as
• Two events are mutually exclusive if they have no
outcomes in common.
• Rule 3. If events A and B are mutually exclusive,
then

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Example 5.9: Computing the Probability
of Mutually Exclusive Events
Dice Example: Die Sum
2
Frequency
1
3 2

• 4 3
5 4
6 5

• B = {2, 3, 12} : P(B) = 4/36

7 6
8 5
9 4

•
10 3
11 2
12 1
Sum 36

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Non-Mutually Exclusive Events
• The notation (A and B) represents the intersection
of events A and B – that is, all outcomes
belonging to both A and B.
• Rule 4. If two events A and B are not mutually
exclusive, then

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Example 5.10: Computing the Probability
of Non-Mutually Exclusive Events
Dice Example: Die Sum Frequency
2 1
3 2
• 4 3
5 4
6 5

• 7 6
8 5
9 4

• 10
11
3
2
12 1
• Sum 36

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Joint and Marginal Probability
• The probability of the intersection of two events is
called a joint probability.
• The probability of an event, irrespective of the
outcome of the other joint event, is called a
marginal probability.

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Application of Joint and Marginal
Probability
• A sample of 100 individuals were asked to evaluate their preference for three
new proposed energy drinks in a blind taste test.
• The sample space consists of two types of outcomes corresponding to each
individual: gender (F = female or M = male) and brand preference
• Define a new sample space consisting of the outcomes that reflect the different
combinations of outcomes from these two sample spaces.
– = the respondent is female and prefers brand 1
– = the respondent is female and prefers brand 2
– = the respondent is female and prefers brand 3
– = the respondent is male and prefers brand 1
–
= the respondent is male and prefers brand 2
– = the respondent is male and prefers brand 3

• The probability of each of these events is the intersection of the

gender and brand preference event. For example,

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Example 5.11: Applying Probability
Rules to Joint Events
• Energy Drink Survey
• The joint probabilities of gender and brand preference are
calculated by dividing the number of respondents
corresponding to each of the six outcomes listed above
by the total number of respondents, 100.
– E.g.,

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Example 5.11 Continued
• The marginal probabilities for gender and brand preference
are calculated by adding the joint probabilities across the
rows and columns
– E.g., the event F, (respondent is female) is comprised of the
outcomes and therefore

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Example 5.11 Continued
• Events F and M are mutually exclusive, as are events
since a respondent may be only male or female and prefer exactly one of
the three brands. We can use Rule 3 to find, for example,

• Events F and however, are not mutually exclusive because a

respondent can be both female and prefer brand 1. Therefore, using
Rule 4, we have

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Joint/Marginal Probability Rule
• Calculations of marginal probabilities leads to the
following probability rule:
• Rule 5. If event A is comprised of the outcomes
and event B is comprised of the
outcomes {B1, B2, …, Bn} then

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Conditional Probability
• Conditional probability is the probability of
occurrence of one event A, given that another
event B is known to be true or has already
occurred.

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Example 5.12: Computing a Conditional
Probability in a Cross-Tabulation
• Suppose we know a respondent is male. What is the probability that he
prefers Brand 1?
• Using cross-tabulation: Of 63 males, 25 prefer Brand 1, so the
probability of preferring Brand 1 given that a respondent is male
• Using joint probability table: divide the joint probability 0.25 (the
probability that the respondent is male and prefers brand 1) by the
marginal probability 0.63 (the probability that the respondent is male).

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Example 5.13: Conditional Probability
in Marketing
• Apple Purchase History
• The PivotTable shows the count of
the type of second purchase given
that each product was purchased
first.
• Probability of purchasing an iPad
given that a customer already
purchased an iMac

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Conditional Probability Formula
• The conditional probability of an event A given that
event B is known to have occurred is

• We read the notation as “the probability

of A given B.”

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Example 5.14: Using the Conditional
Probability Formula

• Summary of conditional probabilities:

• Applications in marketing and advertising.

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Variations of the Conditional
Probability Formula

•
•
– Note:

• Multiplication law of probability:

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Extension of the Multiplication Law
• Suppose are mutually exclusive
events whose union comprises the entire sample
space. Then

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Example 5.15: Using the
Multiplication Law of Probability
• “Texas Hold ‘Em” Poker
• Probability of pocket aces (two aces in hand)
•
•

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Independent Events
• Two events A and B are independent if

• Energy Drink Survey example: the probability of

preferring a brand depends on gender.
• Thus, we may say that brand preference and gender
are not independent.

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Example 5.16: Determining If Two
Events Are Independent
• Are Gender and Brand Preference Independent?
•

• Because Gender and Brand Preference

are not independent.
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Multiplication Law for Independent
Events
• If two events are independent, then we can simplify
the multiplication law of probability in equation (5.7).

• by substituting

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Example 5.17: Using the Multiplication
Law for Independent Events
Dice Rolls:
• Rolling pairs of dice are independent events since
they do not depend on the previous rolls.
•

•
• Using formula (5.9):

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Random Variables
• A random variable is a numerical description of
the outcome of an experiment.
• A discrete random variable is one for which the
number of possible outcomes can be counted.
• A continuous random variable has outcomes
over one or more continuous intervals of real
numbers.

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Example 5.18: Discrete and
Continuous Random Variables
Examples of discrete random variables:
• outcomes of dice rolls
• whether a customer likes or dislikes a product
• number of hits on a Web site link today
Examples of continuous random variables:
• weekly change in DJIA
• daily temperature
• time between machine failures

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Probability Distributions
• A probability distribution is a characterization of
the possible values that a random variable may
assume along with the probability of assuming
these values.
• We may develop a probability distribution using
any one of the three perspectives of probability:
classical, relative frequency, and subjective.

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Example 5.19: Probability Distribution
of Dice Rolls

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Empirical Probability Distributions
• We can calculate the relative frequencies from a sample
of empirical data to develop a probability distribution.
Because this is based on sample data, we usually call
this an empirical probability distribution.
• An empirical probability distribution is an approximation of
the probability distribution of the associated random
variable, whereas the probability distribution of a random
variable, such as one derived from counting arguments,
is a theoretical model of the random variable.

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Empirical Probability Distribution
Example

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Discrete Probability Distributions
• For a discrete random variable X, the probability
distribution of the discrete outcomes is called a probability
mass function and is denoted by a
mathematical function,

– The symbol represents the value of the random

variable X and is the probability.
• Properties:
– the probability of each outcome must be between 0 and 1
– the sum of all probabilities must add to 1

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Example 5.21: Probability Mass
Function for Rolling Two Dice
• values of the random variable X, which
represents sum of the rolls of two dice
–

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Cumulative Distribution Function
• A cumulative distribution function, specifies
the probability that the random variable X assumes
a value less than or equal to a specified value, x;
that is,

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Example 5.22: Using the Cumulative
Distribution Function
• Probability of rolling a 6 or less
• Probability of rolling between 4 and 8:

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Expected Value of a Discrete Random
Variable
• The expected value of a random variable
corresponds to the notion of the mean, or average,
for a sample.
• For a discrete random variable X, the expected
value, denoted is the weighted average of all
possible outcomes, where the weights are the
probabilities:

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Example 5.23: Computing the
Expected Value
• Rolling two dice
–

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Example 5.24: Expected Value on
Television
The Apprentice
• Teams were required to select an artist (mainstream or avant-garde)
and sell their art for the most money possible. A simple expected value
calculation would have easily predicted the winner.
Deal or No Deal
• Contestant had 5 briefcases left with $100, $400, $1000, $50,000 or
$300,000 in them.
• Expected value of briefcases is $70,300.
• Banker offered contestant $80,000 to quit, which was higher than the
expected value. The probability of choosing the $300,000 briefcase
was only 0.2, so the decision should have been easy to make.

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Expected Value and Decision Making
• The expected value is a “long-run average” and is
appropriate for decisions that occur on a repeated
basis.
• For one-time decisions, however, you need to
consider the downside risk and the upside potential
of the decision.

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Example 5.25: Expected Value of a
Charitable Raffle
• Cost of raffle ticket is $50.
• 1000 raffle tickets are sold.
• Winning prize is $25,000.
•
• If you played this game repeatedly over the long run, you
would lose an average of $25.00 each time you play.
• However, for any one game, you would either lose $50 or
win $24,950.
– Is the risk of losing $50 worth the potential of winning $24,950?

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Example 5.26: Airline Revenue
Management
• Full and discount airfares are available for a flight.
• Full-fare ticket costs $560.
• Discount ticket costs $400.
• X = ticket price paid
• p = 0.75 (the probability of selling a full-fare ticket)
•
• The airline should not discount full-fare tickets because
the expected value of a full-fare ticket is greater than the
cost of a discount ticket.
• Break-even point:
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Variance of a Discrete Random
Variable
• The variance, of a discrete random
variable X is a weighted average of the squared
deviations from the expected value:

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Example 5.27: Computing the
Variance of a Random Variable
• Rolling two dice

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Bernoulli Distribution
• Two possible outcomes, “success” and “failure,” each with
a constant probability of occurrence; p is the probability of
a success and 1 − p is the probability of a failure.
• Typically, x = 1 represents “success” and x = 0 represents
“failure.”
• Probability mass function:

•
•

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Example 5.28: Using the Bernoulli
Distribution
• The Bernoulli distribution can be used to model
whether an individual responds positively (x = 1), or
negatively (x = 0) to a telemarketing promotion.
• For example, if you estimate that 20% of customers
contacted will make a purchase, the probability
distribution that describes whether or not a particular
individual makes a purchase is Bernoulli with p = 0.2.

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Binomial Distribution
• Models n independent replications of a Bernoulli experiment, each with
a probability p of success. (Deals with a fixed number of independent
trials or experiments.)
– X represents the number of successes in these n experiments.
• Probability mass function:

• Expected value

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Example 5.29: Computing Binomial
Probabilities
• Suppose 10 individuals receive a telemarking promotion. Each
individual has a 0.2 probability of making a purchase. Find the
probability that exactly 3 of the 10 individuals make a purchase.
• The probability distribution that x individuals out of 10 calls will make a
purchase is:

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Excel Binomial Distribution Function

• If cumulative is set to TRUE, then this function will provide cumulative

probabilities; otherwise the default is FALSE, and it provides values of
the probability mass function,

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Example 5.30: Using Excel’s Binomial
Distribution Function
• The probability that exactly 3 of 10 individuals will make a
a purchase is False

• The probability that 3 or fewer of 10 individuals will make

a purchase is True

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Poisson Distribution
• Models the number of occurrences in some unit of
measure (often time or distance).
• There is no limit on the number of occurrences.
• The average number of occurrence per unit is a constant
denoted as
• Probability mass function:

• Expected value
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Example 5.31: Computing Poisson
Probabilities
• Suppose the average number of customers arriving at a
Subway restaurant during lunch hour is per hour.
• The probability that exactly x customers arrive during the
hour is given by the Poisson distribution with a mean of 12.

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Excel Poisson Distribution Function

• If cumulative is set to TRUE, then this function will provide cumulative

probabilities; otherwise the default is FALSE, and it provides values of
the probability mass function,

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Example 5.32: Using Excel’s Poisson
Distribution Function
• With the probability that X = 1 is

• The probability that

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Continuous Probability
Distributions
• A probability density function is a mathematical function
that characterizes a continuous random variable.

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Properties of Continuous
Probability Distributions
• Properties
– for all values of x
– Total area under the density function equals 1.
–
– Probabilities are only defined over intervals.
– is the area under the density function between a and b.

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Uniform Distribution
• The uniform distribution characterizes a continuous random variable
for which all outcomes between a minimum (a) and a maximum (b) are
equally likely.
• Density function:

• Cumulative distribution function:

• Expected value
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Example 5.33: Computing Uniform
Probabilities
• Sales revenue for a product varies uniformly each week between
$1000 and $2000.
• Probability that sales revenue will be less than x = $1,300.
–

• Probability that revenue will be between $1,500 and $1,700.

–

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Discrete Uniform Distribution
• A variation of the uniform distribution is one for
which the random variable is restricted to integer
values between a and b (also integers); this is
called a discrete uniform distribution.

– Example: roll of a single die. Each of the numbers 1

through 6 have a probability of occurrence.

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Normal Distribution
• is a bell-shaped curve.
• Characterized by 2 parameters:

• Properties
1. Symmetric
2. Mean = Median = Mode
3. Range of X is unbounded.
4. Empirical rules apply

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Excel Normal Distribution Function

–
calculates the cumulative probability.
– If cumulative is set to FALSE, the function simply calculates the
value of the density function which has little practical
application.

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Example 5.34 Using the NORM.DIST
Function to Compute Normal Probabilities
• The distribution for customer demand (units per month) is normal with
mean = 750 and standard deviation = 100.
• Find the probability that demand will be:
1. at most 900 units/month
2. exceed 700 units/month
3. be between 700 and 900 units/month

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Example 5.34: Question 1
• Probability that demand will be at most 900 units, or

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Example 5.34: Question 2
• Probability that demand will exceed 700 units, or
–

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Example 5.34: Question 3
• Probability that demand will be between 700 and 900, or

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The NORM.INV Function
Suppose that we know the cumulative probability
but don’t know the value of x. The Excel function

provides the x value for a given cumulative

probability.

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Example 5.35: Using the NORM.INV
Function
• What level of demand would be exceeded at most
10% of the time?
• Find x such that

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Standard Normal Distribution
• A standard normal distribution is a normal distribution with
a mean of 0 and standard deviation of 1.
– A standard normal random variable is denoted by Z.
– The scale along the z-axis represents the number of standard
deviations from the mean of zero.
– The Excel function finds probabilities for the
standard normal distribution.

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Example 5.36: Computing Probabilities
with the Standard Normal Distribution
• Verify the empirical rules using Excel.
• Example: The probability within one standard deviation
of the mean is is found by the formula
=NORM.S.DIST(1) – NORM.S.DIST(-1)

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Using Standard Normal Distribution
Tables
• Table 1 of Appendix A

• We may compute probabilities for any normal random

variable X having a mean and standard deviation
by converting it to a standard normal random variable Z:

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Example 5.37: Computing Probabilities
with Standard Normal Tables
z .00
• From Example 5.34, what is the 0.0 .5000

probability that demand will be at 0.1 .5398

0.2 .5793
least 900 units/month? 0.3 .6179
0.4 .6554
• 0.5 .6915
0.6 .7257
0.7 .7580
• Using Table 1 in Appendix A, we 0.8 .7881

find:
–
0.9 .8159
1.0 .8413
1.1 .8643
1.2 .8849
1.3 .9032
1.4 .9192
1.5 .9332

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Exponential Distribution
• Models the time between randomly occurring events
• Density function:

• Cumulative distribution function:

• Mean
If the number of events occurring during
an interval of time has a Poisson
distribution, then the time between
events is exponentially distributed.

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Excel Exponential Distribution
Function

As with other Excel probability distribution functions,

cumulative is either TRUE or FALSE, with TRUE
providing the cumulative distribution function.

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Example 5.38: Using the Exponential
Distribution
• The mean time to failure of a critical engine component is
hours. What is the probability of failing before 5000 hours?
–

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Triangular Distribution
• The triangular
distribution is defined
by three parameters: the
minimum, a; maximum,
b; and most likely, c.
• By varying the most
likely value, the
triangular distribution
can be symmetric or
skewed in either
direction

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Triangular Distribution Properties

The triangular distribution is often used when no data

are available to characterize an uncertain variable and
the distribution must be estimated judgmentally.

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Data Modeling and Distribution
Fitting
• Using sample data may limit our ability to predict
uncertain events that may occur because potential values
outside the range of the sample data are not included.
• A better approach is to identify the underlying probability
distribution from which sample data come by “fitting” a
theoretical distribution to the data and verifying the
goodness of fit statistically.
– Examine a histogram for clues about the distribution’s shape.
– Look at summary statistics such as the mean, median, standard
deviation, coefficient of variation, and skewness.

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Example 5.39: Analyzing Airline
Passenger Data
• Sample data on passenger demand for 25 flights

• The histogram shows a relatively symmetric distribution. The mean,

median, and mode are all similar, although there is moderate
skewness. A normal distribution is not unreasonable.
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Example 5.40: Analyzing Airport
Service Times
• Sample data on service times for 812 passengers at an
airport’s ticketing counter

• It appears to be exponential, but there is a difference between the

mean and standard deviation, suggesting that it might be some other
distribution.
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Goodness of Fit

• The basis for fitting data to a probability distribution is a

statistical procedure called goodness of fit.
• Goodness of fit attempts to draw a conclusion about the
nature of the distribution.

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Chi-Square Goodness of Fit Test

• The chi-square goodness of fit test can be

used to determine whether sample data are
representative of some probability distribution.
• The chi-square test can be applied to many
distributions; the only modification to the
procedure that must be made is to use the
proper function to find the cumulative
probabilities of the observed frequency
distribution.

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Example 5.41: Determining Normality
for Airline Passenger Demand Data
• Start with the frequency distribution of the data; these are the
observed frequencies.
• Find the cumulative probability corresponding to the upper limit for
each bin, assuming a normal distribution with the sample mean and
sample standard deviation of the data.
• Find the probability associated with each bin using formula (5.17).
• Multiply the bin probabilities by the number of observations to obtain
the expected frequencies.

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Example 5.41 Continued
• Compute the difference between the observed and expected
frequencies for each bin, square the result, and divide by the
expected frequency for each bin.
• Sum the chi-square calculations for all bins (chi-square statistic).
• Compute the chi-square critical value using the function
=CHISQ.INV.RT(0.05, number of bins - 3).
• Compare the chi-square statistic with the critical value. If the chi-
square statistic is less than or equal to the critical value, then
conclude that the data can be reasonably assumed to be normal.

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Using the CHISQ.INV.RT Function
• CHISQ.INV.RT(probability, deg_freedom)
• The number of degrees of freedom (deg_freedom) used in the
CHISQ.INV.RT function depends on the type of distribution you are
fitting.
• In general, degrees of freedom is the number of bins minus one
minus the number of parameters of the distribution that are estimated
from the data. For the normal distribution, we need to estimate two
parameters — the mean and standard deviation; thus, degrees of
freedom equals the number of bins minus 3 (see step 7 in Example
5.41). For the exponential distribution, we need only estimate one
parameter, lambda, so the degrees of freedom are the number of
bins minus 2.

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100