PROBABILITY

Business Statistics

Dr. Gunjan Malhotra

Assistant Professor
Institute of Management Technology, Ghaziabad
[email protected]
[email protected]
1
Probability is:
 A quantitative measure of uncertainty
 A measure of the strength of belief in the
occurrence of an uncertain event
 A measure of the degree of chance or
likelihood of occurrence of an uncertain event
 Measured by a number between 0 and 1 (or
between 0% and 100%)

2
Probability as a Numerical Measure
of the Likelihood of Occurrence

Increasing Likelihood of Occurrence

0 .5 1
Probability:

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.

3
 Uses of probability

❚ Classical probability models used in

statistical theory
❙ Sensitivity, Specificity, Predictive value
❙ Relative risk
❙ Interpretation of other rates

4
Structure of Probability
• Experiment
• Event
• Elementary Events
• Sample Space
• Unions and Intersections
• Collectively Exhaustive Events
• Complementary Events

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 Experiment
• Process that leads to one of several possible
outcomes *, e.g.:
Coin toss
• Heads, Tails
Throw die
• 1, 2, 3, 4, 5, 6
Pick a card
– AH, KH, QH, ...
Introduce a new product
• Each trial of an experiment has a single observed
outcome.
• The precise outcome of a random experiment is
unknown before a trial.
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Events
• Simple event
– An outcome from a sample space with one
characteristic/Collection of outcomes having a common
characteristic
– e.g., A red card from a deck of cards
 E.g.: Even number

– A = {2,4,6}
• Complement of an event A (denoted A’)
– All outcomes that are not part of event A/ Event A occurs if an
outcome in the set A occurs
– e.g., All cards that are not diamonds
Sample
A’ Space S
Event A
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• Joint event
– Involves two or more characteristics simultaneously
• Example: An ace that is also red from a deck of cards

 Sample Space or Event Set

– Set of all possible outcomes (universal set) for a given
experiment
 Example: Roll a regular six-sided die
– S = {1,2,3,4,5,6}
• Elementary Event
– cannot be decomposed or broken down into other events/
An outcome from a sample space with one characteristic
• Example: A red card from a deck of cards

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 Elementary Events
• A automobile consultant records fuel type
and vehicle type for a sample of vehicles
2 Fuel types: Gasoline, Diesel
3 Vehicle types: Truck, Car, SUV
6 possible elementary events: k e1
Truc
e1 Gasoline, Truck Car e2
oli ne e3
e2 Gasoline, Car Ga s SUV
e4
e3 Gasoline, SUV k e5
Die Truc
e4 Diesel, Truck sel e6
Car
e5 Diesel, Car
SUV
e6 Diesel, SUV
9
Sample Space

The Sample Space is the collection of all possible events

e.g. All 6 faces of a die:

e.g. All 52 cards of a bridge deck:

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Unions and Intersection
 Intersection (And)
–
a set containing all elements in both A and B

A B  A  B
 Union (Or)
–
a set containing all elements in A or B or both

A B
 A B
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Collectively Exhaustive Events

• A set of events is collectively exhaustive if one

of the events must occur
• Example: head or tails

E1 E2 E3

Sample Space with three collectively

exhaustive events
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Complementary Events

• All elementary events not in the event ‘A’ are

in its complementary event.

P
(
Sam
Sp
)1
Sample
Space
A A P
(
A
)
1P
(
A)

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 An example
• An experiment involving a single coin toss
• There are two possible outcomes, Heads and Tails
• Sample space S is {H,T}
• If coin is fair, should assign equal probabilities to 2
outcomes
• Since they have to sum to 1
– P({H}) = 0.5
– P({T}) = 0.5
– P({H,T}) = P({H})+P({T}) = 1.0

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Another example
• Experiment involving 3 coin tosses
• Outcome is a 3-long string of H or T
– S ={HHH,HHT,HTH,HTT,THH,THT,TTH,TTT}
• Assume each outcome is equally likely (equiprobable)
– “Uniform distribution”
• What is probability of the event A that exactly 2 heads
occur?
– A = {HHT,HTH,THH}
– P(A) = P({HHT})+P({HTH})+P({THH})
– = 1/8 + 1/8 + 1/8
– =3/8

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 Probability Concepts
• Mutually Exclusive Events/Disjoint Sets
– If E1 (black card) occurs, then E2 (red card) cannot occur
– E1 and E2 have no common elements
• Example: A card cannot be Black and Red at the same time.
• Independent events
– Occurrence of one does not influence the probability
of occurrence of the other
• Dependent:
– Occurrence of one affects the probability of the other

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Independent vs. Dependent Events
 Independent Events
E1 = heads on one flip of fair coin
E2 = heads on second flip of same coin
Result of second flip does not depend on the result
of the first flip.
 Dependent Events
E1 = rain forecasted on the news
E2 = take umbrella to work
Probability of the second event is affected by the
occurrence of the first event

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 Assigning Probability

• There are three approaches to assess the probability of an uncertain event:

• Objective or Classical Probability Assessment

Number of ways Ei can occur

P(Ei) = Total number of elementary events

 Relative Frequency of Occurrence

Number of times Ei occurs
Relative Freq. of Ei = N

 Subjective Probability Assessment

An opinion or judgment by a decision maker about the
likelihood of an event

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Objective or Classical Probability
 based on equally-likely events
 based on long-run relative frequency of events
 not based on personal beliefs
 is the same for all observers (objective)
 If an experiment has n possible outcomes, this method would assign
a probability of 1/n to each outcome.
 examples:
 toss a coin,
 throw a die,
 pick a card
 gambling models
• applicable to games of chance

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Relative frequency theory
 based on long-run relative frequency of events
 Fifty percent chance of occurrence of a particular event
 Is objective as no personal judgment is involved
 example: toss a coin – head or tale

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
1 6 .15
2 18 .45 4/40
3 10 .25
4 2 .05
40 1.00 20
Subjective Probability

 based on personal beliefs, experiences, prejudices, intuition -

personal judgment
 different for all observers (subjective)
 When economic conditions and a company’s circumstances change rapidly,
then 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.
 examples:
 Super Bowl,
 elections,
 new product introduction,
 snowfall,
 price movements of a particular stock,
 selecting a leader.

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Four Types of Probability

Marginal Union Joint Conditional

P( X ) P( X  Y ) P( X  Y ) P( X | Y )
The probability of The probability of The probability of The probability of
X occurring X or Y occurring X and Y occurring X occurring given
that Y has
occurred

X X Y X Y
Y

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General Law of Addition

The addition law provides a way to compute the

probability of event A, or B, or both A and B occurring.

P(A U B) = P (A or B) = P(A) + P(B) - P(A ∩ B)

Mutually exclusive events:

If A and B are mutually exclusive, then

P(A  B)  0 so P(A  B)  P(A)  P(B)

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Marginal Probability Example

2 2 4
P(Ace) P( Aceand Red)  P( Aceand Black)   
52 52 52

Color
Type Red Black Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52
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Addition Rule for Events That are Mutually
Exclusive - Example
• P (A or B) = P(A) + P(B)
• P(Red or Ace) = P(Red) +P(Ace)
= 26/52 + 4/52 = 30/52
Color
Type Red Black Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52

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Addition Rule for Events That are Not Mutually Exclusive -
Example

P (A or B) = P(A) + P(B) - P(A and B)

P(Red or Ace) = P(Red) +P(Ace) - P(Red and Ace)
= 26/52 + 4/52 - 2/52 = 28/52
Don’t count
the two red
Color aces twice!
Type Red Black Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52

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Conditional Probability

• Conditional Probability - Probability of A given B

P(A  B)
P(A B)  , where P ( B )  0
P(B)

 Independent events:

P(A B)  P(A)
P(B A)  P(B)
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Conditional Probability

Rulesof
Rules ofconditional
conditionalprobability:
probability:

P( A B)  P( A  B) so P( A  B)  P( A B) P( B)
P ( B)
 P( B A) P( A)

If events A and D are statistically independent:

P ( A D )  P ( A)
so P( A  D)  P( A) P( D)
P ( D A)  P ( D )

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Conditional Probability Example (Ques)

• Of the cars on a used car lot, 70% have air

conditioning (AC) and 40% have a CD player (CD).
20% of the cars have both.

• What is the probability that a car has a CD player,

given that it has AC ?

i.e., we want to find P(CD | AC)

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Conditional Probability Example (Ans.)
• Of the cars on a used car lot, 70% have air
conditioning (AC) and 40% have a CD player
(CD).20% of the cars have both.
CD No CD Total
AC 0.2 0.5 0.7
No AC 0.2 0.1 0.3
Total 0.4 0.6 1.0

P(CD and AC) 0.2

P(CD | AC)    0.2857
P(AC) 0.7
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Conditional Probability Example
• Given AC, we only consider the top row (70% of the cars). Of
these, 20% have a CD player. 20% of 70% is about 28.57%.

CD No CD Total
AC 0.2 0.5 0.7
No AC 0.2 0.1 0.3
Total 0.4 0.6 1.0

P(CD and AC) 0.2

P(CD | AC)    0.2857
P(AC) 0.7
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Independent Events

• Two events are independent if and only

if:
P(A | B)  P(A)

• Events A and B are independent when the

probability of one event is not affected by the other
event
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Independent Events- Example
Test the matrix for the 200 executive responses to determine whether industry
type is independent of geographic location.

Geographic Location
Northeast Southeast Midwest West
D E F G
Finance A .12 .05 .04 .07 .28

Manufacturing B .15 .03 .11 .06 .35

Communications C .14 .09 .06 .08 .37

.41 .17 .21 .21 1.00

P( A G) 0.07
P( A | G)    0.33 P( A)  0.28
P(G) 0.21
P( A | G)  0.33 P( A)  0.28 33
Multiplication Rules

• Multiplication rule for two events A and B:

P(A and B)  P(A | B) P(B)

Note: If A and B are independent, then P(A| B)  P(A)

and the multiplication rule simplifies to
P(A and B)  P(A) P(B)

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Multiplication Law-example

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

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 Practice Problem
• Question 1.
• Given the following contigency table:
B B’
A 10 20
A' 20 40

What is the probability of

a. event A?
b. event A’?
c. event A and B?
d. event A or B? 36
 Practice Problem
• Answer 1.
• (a) 30/90 = 1/3 = 0.33
• (b) 60/90 = 2/3 = 0.67
• (c) 10/90 = 1/9 = 0.11
• (d) 30/90 + 30/90 - 10/90 = 50/90 = 5/9
= 0.556

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• Question 2:
• Are large companies less likely to offer board members stock
options than small- to mid sized companies? A survey conducted by
the Segal Company of New York found that in a sample of 189 large
companies, 40 offered stock options to their board members as part
of their non-cash compensation packages. For small-to mid sized
companies, 43 of the 180 surveyed indicated that they offer stock
options as part of their non- cash compensation packages to their
board members (Kemba J. Dunham, “The Jungle: Focus on
Recruitment, Pay and Getting Ahead”, The Wall Street Journal,
August 21, 2001, B6). Construct a contingency table to evaluate the
probabilities. If a company is selected at random, what is the
probability that the company
a. offered stock options to their board members?
b. is small-to mid-sized and did not offer stock options to their
board members?
c. is small- to mid-sized or offered stock options to their board
members?
d. explain the difference in the results in (b) and (c ).

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 Answer 2:

Company Size
Large Small-to-
mid sized
Stock Yes 40 43 83
Options No 149 137 286
189 180 369

• (a) P(offered stock options) = 83/369 = 0.2249

• (b) P(small-to-midsized and did not offer stock options) = 137/369 =
0.3713
• (c) P(small-to-midsized or offered stock options) = (180 + 83 – 43)/369
= 0.5962
• (d) The probability of “small-to-midsized or offered stock options”
includes the probability of “small-to-midsized and offered stock
options”, the probability of “small-to-midsized but did not offer stock
options” and the probability of “large and offered stock options”.

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• Question 3:

A particular brand of women’s jeans is available in

seven different sizes, three different colors, and three
different styles. How many different jeans does the
store manager need to order to have one pair of
each type?

40
• Answer 3:

(b) (7)(3)(3) =63

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Question 4.

• Suppose that 47 % of all Americans have flown

in an airplane at least once and that 28 % of all
Americans have ridden on a train at least
once. What is the probability that a randomly
selected Americans has either ridden on a
train or flown in an airplane? Can this problem
be solved? Under what conditions can it be
solved? If the problem cannot be solved,
what information is needed to make it
solvable?
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Answer 4.
• A = event - flown in an airplane at least once
• T = event - ridden in a train at least once
•
• P(A) = .47 P(T) = .28
•
• P (ridden either a train or an airplane) =
• P(A U T) = P(A) + P(T) - P(A ∩ T) = .47 + .28 - P(A ∩ T)
•
• Cannot solve this problem without knowing the probability of the
intersection.
• We need to know the probability of the intersection of A and T, the
proportion who have ridden both.
•

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Question 5.
• A yield improvement study at a semiconductor manufacturing
facility provided defect data for a sample of 40 wafers. The
following table presents a summary of the responses to two
questions: “Were particles found on the die that produced the
wafer?” and “Is the wafer good or bad?”
• Condition of Die
• Quality of Wafer No Particles Particles Totals
• Good 320 14 334
• Bad 80 36 116
• Total 400 50 450

• a. Suppose you know that a wafer is bad. What then is the probability that it
was produced from a die that had particles?
• b. Suppose you know that a wafer is good. What then is the probability that it
was produced from a die that had particles?
• c. Are the two events, a good wafer and a die with no particle, statistically
independent? Explain.

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Answer 5:

(a)P (had particles | bad) = 36/116 = 0.3103

(b) P (had particles | good) = 14/334 = 0.0419

(c) P (no particles | good ) = 320/334 = 0.9581

P (no particles) = 400/450 = 0.8889

Since P (no particles | good ) ≠ P (no particles), “a
good wafer” and “a die with no
particle” are not statistically independent.

45
Question 6:

• A box of nine golf gloves contains two left-handed gloves and

seven right-handed gloves.
a. If two gloves are randomly selected from the box without
replacement, what is the probability that both gloves selected
will be right-handed?
b. If two gloves are randomly selected from the box without
replacement, what is the probability there will be one right-
handed glove and one left-handed glove selected?
c. If three gloves are selected with replacement, what is the
probability that all three will be left-handed?
d. If you are sampling with replacement, what would be the
answer to (a) and (b)?

46
 Answer 6:
• (a) P(2 right-handed gloves) = (7/9) (6/8)
= 42/72 = 7/12 = 0.5833

• (b) P(1 right-handed and 1 left-handed glove) = (7/9)

(2/8) + (2/9) (7/8) = 28/72 = 7/18 = 0.3889

• (c) P(3 left-handed gloves) = (2/9)3

• (d) (a) P(2 right-handed gloves) = (7/9) (7/9)

= 49/81= 0.6049
(b) P(1 right-handed and 1 left-handed glove)
= (7/9) (2/9) + (2/9) (7/9) = 28/81 = 0.3456

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Question 7:

• The probability that a consumer entering a retail

outlet for microcomputers and software packages
will buy a computer of a certain type is 0.15. The
probability that the consumer will buy a particular
software package is 0.10. There is 0.05 probability
that the consumer will buy both the computer and
software package. What is the probability that the
consumer will buy the computer or the software
package or both?

48
Answer 7:

• (C U S)= 0.15 + 0.10 – 0.05 = 0.20

49
Question 8:

• The probability that a bank customer will

default on a loan is 0.04 if the economy is high
and 0.13 if the economy is not high. Suppose
the probability that the economy will be high
is 0.65. What is the probability that the person
will default on the loan?

50
Answer 8:

Let D, H be the events: customer defaults, economy is

high.
P(D | H) = 0.04
P(D | H ) = 0.13 P(H) = 0.65
P(D) = P(D | H) P(H) + P(D| H)P(H)

= (.04)(.65) + (.13)(.35) = 0.0715

51
Question 9:

• In a takeover bid for a certain company,

management of the raiding firm believes that
the takeover has a 0.65 probability of success
if a member of the board of the raided firm
resigns, and a 0.30 chance of success if she
does not resign. Management of the raiding
firm further believes that the chances for a
resignation of the member in question are
0.70. What is the probability of a successful
takeover?
52
 Answer 9:

Let T,R be the events: successful takeover, resignation

of a board member.
P(T | R) = 0.65
P(T| R) = 0.30 P(R) = 0.70
P(T) = P(T | R)P(R) + P(T | R)P(R)
= (.65)(.7) + (.30)(.30) = 0.545

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Questions???

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