QUANTITATIVE AND

RESEARCH METHODS IN
BUSINESS

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UNIT – I
Probability – Rules of Probability - Binomial –
Poisson and Normal Distribution – their
application in Business and Industrial
Problems - Baye’s theorem and its
application.
Risk and uncertainty in decision making –
Minimax, Maximim and Regret criteria –
Hurwitz and Laplace Criteria in Business
Decision Making – Decision Tree
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 Probability Concepts

Experiment: Any Physical process that is

observed and the results are noted is
called an experiment.
Two types of Experiment
1. Deterministic Experiment
2. Non-deterministic or Random
Experiment.

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 Deterministic Experiment
If the results can be predicted
within the certainty to its performance of
the experiment, then it is called
deterministic experiment.
Example: An experiment conducted to verify
Newton’s law of motion

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 Non-deterministic or Random
Experiment
Any experiment if, when repeated
under same conditions, the outcome cannot
be predicted, such experiment is called non-
deterministic or random experiment.
Example: Tossing a coin or a die

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 Basic Definitions

Sample Space (S): The set of all possible

outcomes of a random experiment is called
sample space
Example: In tossing a die the sample space is
S={1,2,3,4,5,6}
Event (A): An event is a subset of a Sample
Space

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 Probability of an Event:
In any random experiment, the
probability of an even is defined as

n( A) Number of favourable occurance

P ( A)  
n( S ) Total number of occurances

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 Problems:
1. Find the chance of getting an even number in tossing a
die?
2. Find the chance of drawing a King card in a well
shuffled pack of 52 cards?
3. Find the chance of drawing a W ball in a bag containing
4 W 5 B ball?
4. Find the chance of drawing a number from the first 25
Natural numbers that is divisible by 4?
5. Find the chance of getting a sum 9 in tossing 2 dice?
6. Find the chance of drawing 2 W balls in a bag of 4 W
and 6 R?
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7. Find the probability of drawing a King and and Ace
card in a well shuffled pack of 52 cards?
8. Find the probability of drawing 3 King cards in a well
shuffled pack of 52 cards?
9. Find the probability of getting at least 2 H in tossing 3
coins?
10. Find the chance of getting a Head in tossing 2 coins?

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 Mutually Exclusive Events
Two or more events are said to be
mutually exclusive, if happening of one
event prevents the happening of all other
events.
Example: In tossing a coin the event of
getting H is mutually exclusive to the event
of getting T.

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 Exhaustive Event
An event is said to be exhaustive if
it takes all possible values of the sample
space.

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 Axioms of Probability
Let A be an event associated with a
random experiment, then
a) 0  P(A) 1
b) P(S) = 1
c) If A and B are mutually exclusive, then
P(A  B) = P(A) + P(B).

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 Basic Laws
Probability of an impossible event is always
zero.
Probability of a complement of an event is
P ( A)  1  P ( A )
Addition Theorem: If A and B are any two
events then, .
P(A  B) = P(A) + P(B) – P (A  B)

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 Conditional Probability or
Dependent Events
If the occurrence of one event
depends on the occurrence of the other
event, then two events are said to be
dependent events. i.e., The conditional
probability of event A when the probability
of event B is known
P( A  B)
P( A / B) 
P( B)
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 Independent events
If the occurrence ofone event does not depend
on the occurrence of other event, then the
events are said to be independent.

P ( A  B)  P( A).P( B)

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 Problems:
1. Find the probability of drawing a King or an Ace
card in a well shuffled pack of 52 cards?
2. One integer is chosen at random from 1 to 100. What
is the probability that the chosen number is divisible
by 6 or 8.
3. When two dice are thrown, find the probability that
the sum is divisible by 3 or 4?
4. If P(AB) = 3 /4 and P (AB) = 1 /4 and P(A) = 1/3
find P(B) and P(A/B)?
5. A box contains 3 W and 4 B balls, 2 balls are
removed in succession, without replacement. What is
the probability that both are black?

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 6. If A and B are independent then PT A and Bare also
independent?
7. If A and B are independent, then P.T. A and B are also
independent?
8. Find the probability of drawing a King card or a
diamond card in a pack?
9. Find the probability of drawing a number that is
divisible by 2 or 5 in a set of Natural numbers from 1 to
20?
10. A, B and C toss a coin in an order. The one who gets
H first wins. Find the respective chances of winning.

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 Baye’s Theorem
Let A1, A2, …, An be the set of
mutually exclusive and exhaustive events
and B be any event associated
n
with Ai, i =
1,2,3,…, then P( B)   P( Ai ) P( B / Ai )
i 1

P ( Ai ) P ( B / Ai )
P( Ai / B )  n

 P( A ) P( B / A )
i 1
i i

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 Problems
1. In a bolt factory machines A, B and C
manufacture 25%, 35% and 40% of the
total. Of their output 5%, 4% and 2% are
defective bolts. A bolt is drawn at random
and found to be defective. What is the
probability that this bolt is manufactured by
machine A or B or C.

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 2. 3 persons X,Y and Z are being considered
for the appointment of VC of a university,
whose chance of getting the post are in the
ration 2:3:5. The possibility that X is
selected will introduce Internal Assessment
in the university structure is 0.3, and the
corresponding values for Y and Z are 0.4
and 0.7. Find the probability that the IA will
be introduced.

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3. An aircraft emergency locator transmitter
(ELT) is a device designed to transmit a
signal in case of crash. The Company A
makes 80%, Company B makes 15% and
Company C makes 5% of them. The ELT’s
made by A have a 4% rate of defects, B has
6% rate of defects and C has 9% rate of
defects.
If a randomly selected ELT is then tested
and found to be defective, find the
probability that it was made by Company B.
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4. Two Masked Robbers: Two masked robbers try to
rob a crowded bank during the lunch hour but the
teller presses a button that sets off an alarm and
locks the front door. The robbers realizing they are
trapped, throw away their masks and disappear
into the chaotic crowd. Confronted with 40 people
claiming they are innocent, the police gives
everyone a lie detector test. Suppose that guilty
people are detected with probability 0.85 and
innocent people appear to be guilty with
probability 0.08. What is the probability that Mr.
Smith was one of the robbers given that the lie
detector says he is?
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5. Manufacturing Baye’s: Factory has three types of
machines producing an item. Probabilities that the
item is I quality if it is produced on i-th machine are
given in the following table:
machine probability of I quality
1 0.8
2 0.7
3 0.9
The total production is done 30% on type I machine,
50% on type II, and 20% on type III. One item is
selected at random from the production. (i) What is
the probability that it is of I quality? (ii) If it is of
first quality, what is the probability that it was
produced on the machine I?
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6. An insurer has 3 types of auto insurance
policyholders. 50 % are low risk (L). The
probability that low-risk policyholder will
file a claim is 0.1. Another 30% are
moderate risk (M). The probability that a
moderate risk policyholder will file a claim
is 0.2. Finally 20% of them are high risk
and the probability that they will file a
claim is 0.5. If a policy holder files a claim
find the probability that he is high risk
policy holder.
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7. A manufacturing company has a
fabrication plant and assembly line. The
fabrication plant has 60% of employees
and the assembly line 40%. During the
past year 35% of workers in the
fabrication plant sustained injuries and 20
% of assembly line workers had injuries.
a) What percentage of all workers had
injuries in this period?
b) If an employee has injury, what is the
probability that he worked on assembly
line.
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8. Two jar contains coins. Jar I contains 5
pennies, 4 nickel and 6 dimes. Jar II
contains 6 pennies, 4 nickel and 2 dimes. A
jar is selected at random and a coin is
selected from the jar. If the coin is nickel,
what is the probability that it came from Jar
II.

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 9. A skin test for a disease is less expensive
but less accurate than X-ray. In a country
20% of population has this disease. For a
person with disease, the skin test is positive
95% of the time. If a person does not have
the disease, it will be positive 30% of the
time. What is the probability that a person
who tests positive does not have the disease
and what is the probability that a person
who tests negative has the disease.

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 Random Variable
A random variable is a real valued function
which assigns real numbers to every
element of the sample function S
Types of Random Variable
Discrete Random Variable
Continuous Random Variable

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 Discrete Random Variable
If X is a random variable which take finite
number of values, then X is called discrete
random variable and the corresponding
probability distribution P(X) is called
probability mass function which satisfies
the following conditions
P( X )  0

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 P( X )  1 29
 Continuous Random Variable
If X takes all the values defined within an
interval (a, b) then X is called continuous
random variable whose probability
distribution is given by f(x), called
probability density function which satisfies
the following conditions
f ( x)  0


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 f ( x)dx  1

30
 Expectation of Random variable
The expected value of a random variable X
denoted by E(X) is defined as the mean
value or the average value given by
  E( X )   X P( X ) for discrete
  x f ( x)dx for continuous

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 Variance
Variance of a random variable X is defined as
the difference between the second order
moment and the square value of the mean
given by

  Var ( X )  E ( X )  ( E ( X ))
2 2 2

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 Binomial Distribution
A trial where only two possible outcomes (p -
probability of success, q – probability of
failure) p, q exists is called Bernoulli trial.
Assumptions:
The number of trials should be finite
The probability of success should be
constant for all the trials
The trials are independent of each other

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 A random variable X which follows
Bernoulli trial is said to follow Binomial
Distribution, if its probability mass function
is given by
n x
P ( X  x)  nC x p q x

Mean = n p
Variance = n p q
S.D =  Var =  n p q

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 Characteristics
It is a discrete distribution which gives the
theoretical probabilities.
It depends on the parameters p or q and n.
The distribution will be symmetrical if p = q. It is
skew-symmetric or asymmetric if p q.
The mode of Binomial distribution is equal to that
value of X which has the largest frequency.
The shape and location of a BD changes as p –
changes for a given n.

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 Poisson Distribution
Poisson Distribution is a limiting case of
Binomial under the conditions:
n – the number of trials in indefinitely large,
n 
p – the probability of success is very small,
p 
n p =  for some constant

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 - Contd
A discrete random variable X is said to follow
Poisson distribution if its probability mass
function is given by

e  x
P( X  x) 
x!
Mean = variance = 

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 Characteristics
The RV X should be discrete.
A dichotomy exists. ie., the happening of the
events must be of two alternatives such as
success or failure.
Statistical independence is assumed. I.e, it is
applicable to those cases where the
happening of one event does not affect the
happening of the other event.
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 Normal Distribution
A continuous random variable X, with mean 
and variance  2
is said to follow Normal
distribution N (  ,  2 ) , if its probability
density function is given by

( x )2
1
f ( x)  e 2 2

 2
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 The normal distribution N(0,1) is called standard normal
distribution with standard normal variable Z  x  


And density function

1  z 2

f ( z)  e 2

2
The values of f(z) is calculated under the are of the normal
curve represented by the bell shaped.

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 Characteristics
The normal distribution is a symmetrical distribution
and the graph is bell shaped.
The curve has a single peak point.
The mean value lies at the centre of the normal
distribution curve
Since the curve is symmetrical, median and mode also
lies at the centre of the normal curve
The tails of the normal curve extend indefinitely and
never touches the horizontal axes.
In normal distribution about 67% of observations lies
between   , about 90 % lies between  2
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 Problems:
Find the probability of getting 7 H in
tossing 10 coins.
A research firm is investigating the safety
of a dangerous road intersection. Past
records indicates an average of 6 accidents
per month. The number of accidents are
distributed according to a PD. Find the
probability of exactly 0, 1, 2, 3 accidents.
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 3. 6 dice are thrown 729 times, how many times do you
expect at least 3 dice to show the number 5 or 6.
4. Out of 800 families with 4 children each, how many
family would you expect to have a) 2 B b) at least 2 B c)
at most 2 G d) children of both sex, assuming equal
probability for B and G.
5. Two dice are thrown 720 times, find the average
number of times in which the number in the first die
exceeds the number in the second die.
6. A car hire firm has 2 cars, which it hires out day by day.
The number of demands for the cars on each day is
distributed as Poisson with mean 1.8. Calculate the
proportion of days in which neither car is used and the
proportion of days on which some demand is refused.

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 7. The number of monthly breakdown of a computer is a
random variable following Poisson distribution with mean 1.5.
Find the probability that the computer will function for a
month a) without any breakdown. b) with only one breakdown
c) with at least one breakdown
8. The probability of success is 1/100. How many trials are
necessary in order the the probability of at least one success is
greater than ½ ?
9. A company finds that the time taken by one of its engineers
to complete or repair a job has ND with mean 40 min and SD
5 min. Find a) P(X<35) b) P(X>48)
10. If X is normally distributed with mean 150 and SD 60
find a) X >180 b) X < 210 c) 120 <X<175

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 11. Employees of a firm invest Rs 1000 per month on
children’s education. Suppose that the investment is ND
with a SD Rs 400. If an employee is randomly selected,
what is the probability that he invests more than Rs 1100
per month? What is the probability the he invests less than
Rs 900 per month.

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If you will begin with certainties, you shall end in doubts, but if you will content to begin with doubts, you shall end in
almost certainties.
Francis Bacon

Decision and Decision making

A decision may be defined as a choice that
can be made from available alternatives.
Decision making is a process of identifying
the acceptable alternative courses of action,
choosing the best alternative and placing it
into operation.

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 Conditions for applying
decision theories
• There should be more that 2 different options or
alternatives. The set of all alternatives is called as
action space.
• Each action should be an outcome; every outcome
should be different from that of the other.
• Information to take decision may be known or
unknown. If it is known, then they are probabilistic in
nature. And if the probability is known then the
decisions are taken with certainty.
• When the probability is unknown then decisions are
taken under uncertain situations.
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 The basic facts that involve in decision making are
•Recognition of a situation that calls for a decision
about what action has to be taken.
•Identification and development of alternative courses
of action
•Evaluation of the alternative
•Choice of one or more alternative
•Implementation of the selected course of action.
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 A few examples of business applications are the following:
• An auditor can use random sampling techniques to audit the
account receivable for client.
•A plant manager can use statistic quality control techniques to
assure the quality of his production with a minimum of testing
or inspection.
•A financial analyst may use regression and correlation to help
understand the relationship of a financial ratio to a set of other
variables in business.
•A market researcher may use test of significant to accept or
reject the hypotheses about a group of buyers to which the firm
wishes to sell a particular product.
•A sale manager may use statistical techniques to forecast sales
for the coming year
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The decisions are also categories in terms of
the degree of certainty that exists in a
situation.
1. Certainty
2. Risk
3. Uncertainty
4. Ambiguity

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 Certainty
This is a state of certainty that exists only
when the decision maker knows the
available alternatives and the conditions and
consequence of those actions.
Making decisions under certainty assumes
that the decision maker has all the necessary
information about the problem.

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 Risk
A state of risk exists when the decision maker
is aware of all the alternatives, but unaware
of the consequences. In this case the
decision maker at best can make a guess as
to which alternative to choose.

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 Uncertainty
The most significant decisions made in
today’s complex environment are
formulated under uncertainty, where there is
an unawareness of all the alternatives and
so also the outcomes. The decision making
functions under uncertainty least us to
“Probability Theory”.

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 Ambiguity
This is the most difficult decision, where the
problem itself is not clear. i.e, the
alternative courses of action are difficult to
identify and the information about the
consequences is not available.

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 Pay-off Matrix
The consequence of courses of action for
each event is evaluated in terms of money,
time or any other values.
If there are ‘m’ possible acts and ‘n’ states
of nature, then there will be m x n
consequences, which is represented in the
form of matrix called pay-off matrix

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 The optimum solution of the given pay-off matrix can be
found by

Maximin criteria
Maximax criteria
Minimax Regret criteria
Laplace criteria
Hurwitz Alpha criteria

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 Maximin Criteria (Pessimistic)
This criteria is designed to select the action
alternative that maximizes the minimum
monetary pay-off. Therefore the decision
maker has to
 determine the least desirable consequence that
can occur with respect to the action alternative
under consideration
 select the action such that it maximizes the
minimum pay off

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 Maximax Criteria (Optimistic)
The decision maker should select that
particular strategy under which it is possible
for him to receive the most favourable pay-
off. (i.e) the decision maker should
determine the most desirable consequence
that occur for each strategy under
consideration and select an optimal action
where the strategy is maximum.

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 Minimax Regret Criteria
The decision maker may regret after the
decision has been made and the state of
nature has occurred.

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 Laplace Criteria
The three decision criteria discussed above are
based on the assumptions that without any
previous experience it is not worthwhile to assign
probability values to various events.
The Laplace criteria uses all the information
by requiring the decision maker to assign equal
probabilities to the possible pay-off foe each
action where the expected value is give by
1
E v  [ p11  p12  ...  p1m ]
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 Hurwicz Alpha Criteria
The pessimistic and optimistic criteria
which were discussed may be considered as
two extremes on the scale of optimistic
approach.
In this the decision maker’s degree of
optimism is represented by , the
coefficient of optimism.

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 -contd
If =0, then it corresponds to the maximin
criteria and if =1, then it corresponds to
maximax criteria.
The decision index by this coefficient of
optimism is defined as
D1   . Max payoff  (1   ) Min payoff

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 Problems:
1. The following matrix gives the pay-off of different
strategies in different conditions (States of nature)
N1 N2 N3 N4
S1 4000 -100 6000 18000
S2 20000 5000 400 0
S3 20000 15000 -2000 1000

Apply decision theory and find the best strategy at different

criteria’s with optimistic coefficient = 0.7

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 2. A business man has 3 options open to him and each of
which can be followed by any one of the 4 possible events

Action A B C D
S1 8 0 -10 6
S2 -4 12 18 -2
S3 14 6 0 8
1. If he adopts maximax criteria which act should he
choose.
2. If he uses expected values what action should be chosen
3. If the criteria of choice is minimax regret, what action
should be chosen.
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 3. The pay-off matrix in an uncertain situation is given as

N1 N2 N3 N3
S1 300 -100 500 1700
S2 1900 400 300 0
S3 1900 1400 -300 900
S4 -110 900 300 1400
When  = 0.5 find the best strategy under different
situations.

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 4. The Investment Decision-Making Problem

A states of nature
c Medium No
t Growth Growth Change Low
i G MG NC Low
o Bonds 12 8 7 3
n stocks 15 9 5 -2
s deposit 7 7 7 7

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 5. A management is faced with the problem of choosing 1
out of 3 product for manufacturing. The demand for each
product may turn out to be good, fair or poor. The
probability for each trial of demand are estimated below.
Product G F P
A 0.75 .15 0.1
B 0.6 0.3 0.1
C 0.5 0.3 0.2
The estimated profit and loss under 3 states of demand are
given as

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 Product G F P
A 35k 15k 5k
B 50 20 3
C 60 30 20
Calculate the estimated value of choice of alternative and
suggest the best for management?

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 Bayesian Approach of decision
making
The business executives possess some information
in a rough form, which helps them to arrive at a
chance of occurrences (strategies) of various events
(states of nature).
Bayesian approach comprises 4 types of analysis
 Prior Analysis
 Pre-posterior Analysis
 Posterior Analysis
 Sequential Analysis

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 Prior Analysis
The process of arriving a decision based on
the subjective probability is called prior
analysis in Bayesian Theory.
This includes the following steps:
Step 1: Based on the set of objectives identify
the alternative course of action which need
to be considered.

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Step 2: Identify the likely events (states of
nature) that would determine the pay-off of
each course of action.
Step 3: Compute the numerical values to the
pay-off matrix for each course of action.
Step 4: Assign a numerical value from the
occurrence of possible events.
Step 5: Calculate the weighted average
(Expected value) of the pay-off assigned to
each course of action.
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Step 6: Asses the exposure to both gain and
loss associated with each course of action.
Step 7: Select among the alternative course of
action, on the basis of the combination of
the expected values and the exposure of
gain and loss (ie) more consistent with the
decision makers objective.

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 Pre-posterior Analysis
Sometimes a decision maker has an
opportunity to delay in his final decisions
until more data affecting the problem is
collected. The evaluation of strategy that
includes collecting information before
taking final action is know as pre-posterior
analysis.

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 Posterior Analysis
In some cases of uncertainty, the decision
maker collects additional data or is provided
with relevant data which changes his prior
perception about the problem. Therefore,
when new data is implemented to avoid the
previous judgments, then the decision
maker is said to perform posterior analysis.

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 Sequential Analysis
In Bayesian approach, when pre-posterior
analysis is applied to multi stage decision
problems then it is referred as sequential
analysis.

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 Decision Tree
A decision tree is a graphic display of the
available action options to the decision
maker and the sequence of events.
In constructing a decision tree it is
convention to use symbol to denote the
decision point and symbol to denote the
situation of uncertainty.

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 -contd
Branches coming out of decision point are the
representation of immediate mutually exclusive
alternative action open to the decision maker.
The set of all branches from any decision point is
called fork and the fork from which no further
branches emanate is called terminal fork.
The position at the base of the pork representing
the first choice among the acts is called the origin
and the outer end of any branch from which no
further branches comes out is called end position.

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 Problems:
1. Company ABC has developed a new line of products. Top
management is attempting to decided on the appropriate
marketing and production strategy. Three strategies A, B
and C are being considered. Managements bets estimate of
net profit is each case is given in the following pay-off table

Managements best estimate of the probabilities of a strong or a

weak market are 0.45 and 0.55 respectively. Draw a decision
tree to represent the strategies of different products?

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 S 0.45
30

W 0.55 -8
20
A S
B
7
C W

S
5

W
15
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 2. Mr. X had to decided whether or not to drill a
well in his farm. In his village, only 40% of wells
drilled were successful at 250 feet of depth. Some
of the farmers who did not get water at 250 feet
drilled further up to 300 feet, but only 10% struck
water at 300 feet. Cost of drilling is Rs 60/- per
feet. Mr. X has estimated that he would pay Rs
20,000 during a 5 year period in his present value
terms. If he continues to bay water from
neighbour, rather than go for a well which you
would have life for 5 years. Frame a decision tree
to the above problem.

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 Do not drill
Rs 20,000

Water struck(0.4) Rs 15,000

Water struck(0.1)Rs 18,000
Drills up to 300 f
Drills up
to 250f Rs 38,000
No water(0.9)
No water(0.6)
Rs 35,000
Do no drill
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