PROBABILITY
Outline
Experiments, Counting Rules,
and Assigning Probabilities
Events and Their Probability
Some Basic Relationships
of Probability
Conditional Probability
Uncertainties
Managers often base their decisions on an analysis
of uncertainties such as the following:
What are the chances that sales will decrease
if we increase prices?
What is the likelihood a new assembly method
will increase productivity?
What are the odds that a new investment will
be profitable?
Probability
Probability is a numerical measure of the likelihood
that an event will occur.
Probability values are always assigned on a scale
from 0 to 1.
A probability near zero indicates an event is quite
unlikely to occur.
A probability near one indicates an event is almost
certain to occur.
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.
An Experiment and Its Sample Space
An experiment is any process that generates well-
defined outcomes.
The sample space for an experiment is the set of
all experimental outcomes.
An experimental outcome is also called a sample
point.
An Experiment and Its Sample Space
Experiment Experiment Outcomes
Toss a coin Head, tail
Inspection a part Defective, non-defective
Conduct a sales call Purchase, no purchase
Roll a die 1, 2, 3, 4, 5, 6
Play a football game Win, lose, tie
An Experiment and Its Sample Space
Example: Bradley Investments
Bradley has invested in two stocks, Markley Oil
and Collins Mining. Bradley has determined that the
possible outcomes of these investments three months
from now are as follows.
Investment Gain or Loss
in 3 Months (in $000)
Markley Oil Collins Mining
10 8
5 2
0
20
A Counting Rule for
Multiple-Step Experiments
If an experiment consists of a sequence of k steps
in which there are n1 possible results for the first st
n2 possible results for the second step, and so on,
then the total number of experimental outcomes is
given by (n1)(n2) . . . (nk).
A helpful graphical representation of a multiple-ste
experiment is a tree diagram.
A Counting Rule for
Multiple-Step Experiments
Example: Bradley Investments
Bradley Investments can be viewed as a two-step
experiment. It involves two stocks, each with a set of
experimental outcomes.
Markley Oil: n1 = 4
Collins Mining: n2 = 2
Total Number of
Experimental Outcomes: n1n2 = (4)(2) = 8
Tree Diagram
Example: Bradley Investments
Markley Oil Collins Mining Experimental
(Stage 1) (Stage 2) Outcomes
Gain 8 (10, 8) Gain $18,000
(10, -2) Gain $8,000
Gain 10 Lose 2
Gain 8 (5, 8) Gain $13,000
Lose 2 (5, -2) Gain $3,000
Gain 5
Gain 8
(0, 8) Gain $8,000
Even
(0, -2) Lose $2,000
Lose 20 Lose 2
Gain 8 (-20, 8) Lose $12,000
Lose 2 (-20, -2) Lose $22,000
Counting Rule for Combinations
https://www.mathsisfun.com/combinatorics/combinations-permutations.html
Number of Combinations of N Objects
Taken n at a Time
A second useful counting rule enables us to count
the number of experimental outcomes when n objects
are to be selected from a set of N objects.
N N!
CnN
n n !(N n )!
where: N! = N(N 1)(N 2) . . . (2)(1)
n! = n(n 1)(n 2) . . . (2)(1)
0! = 1
Counting Rule for Permutations
https://www.mathsisfun.com/combinatorics/combinations-permutations.html
Number of Permutations of N Objects
Taken n at a Time
A third useful counting rule enables us to count
the number of experimental outcomes when n
objects are to be selected from a set of N objects,
where the order of selection is important.
N N!
PnN n !
n (N n )!
where: N! = N(N 1)(N 2) . . . (2)(1)
n! = n(n 1)(n 2) . . . (2)(1)
0! = 1
Assigning Probabilities
Basic Requirements for Assigning Probabilities
1. The probability assigned to each experimental
outcome must be between 0 and 1, inclusively.
where:
Ei is the ith experimental outcome
and P(Ei) is its probability
Assigning Probabilities
Basic Requirements for Assigning Probabilities
2. The sum of the probabilities for all experimental
outcomes must equal 1.
where:
n is the number of experimental outcomes
Assigning Probabilities
Classical Method
Assigning probabilities based on the assumption
of equally likely outcomes
Relative Frequency Method
Assigning probabilities based on experimentation
or historical data
Subjective Method
Assigning probabilities based on judgment
Classical Method
Example: Rolling a Die
If an experiment has n possible outcomes, the
classical method would assign a probability of 1/n
to each outcome.
Experiment: Rolling a die
Sample Space: S = {1, 2, 3, 4, 5, 6}
Probabilities: Each sample point has a
1/6 chance of occurring
Relative Frequency Method
Example: Lucas Tool Rental
Lucas Tool Rental would like to assign probabilities
to the number of car polishers it rents each day.
Office records show the following frequencies of daily
rentals for the last 40 days.
Number of Number
Polishers Rented of Days
0 4
1 6
2 18
3 10
4 2
Relative Frequency Method
Example: Lucas Tool Rental
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
Subjective Method
When economic conditions and a company’s
circumstances change rapidly it might be
inappropriate to assign probabilities based solely o
historical data.
We can use any data available as well as our
experience and intuition, but ultimately a probabil
value should express our degree of belief that the
experimental outcome will occur.
The best probability estimates often are obtained b
combining the estimates from the classical or relat
frequency approach with the subjective estimate.
Subjective Method
Example: Bradley Investments
An analyst made the following probability estimates.
Exper. Outcome Net Gain or Loss Probability
(10, 8) $18,000 Gain .20
(10, 2) $8,000 Gain .08
(5, 8) $13,000 Gain .16
(5, 2) $3,000 Gain .26
(0, 8) $8,000 Gain .10
(0, 2) $2,000 Loss .12
(20, 8) $12,000 Loss .02
(20, 2) $22,000 Loss .06
Events and Their Probabilities
An event is a collection of sample points.
The probability of any event is equal to the sum of
the probabilities of the sample points in the event.
If we can identify all the sample points of an
experiment and assign a probability to each, we
can compute the probability of an event.
Events and Their Probabilities
Example: Bradley Investments
Event M = Markley Oil Profitable
M = {(10, 8), (10, 2), (5, 8), (5, 2)}
P(M) = P(10, 8) + P(10, 2) + P(5, 8) + P(5, 2)
= .20 + .08 + .16 + .26
= .70
Events and Their Probabilities
Example: Bradley Investments
Event C = Collins Mining Profitable
C = {(10, 8), (5, 8), (0, 8), (20, 8)}
P(C) = P(10, 8) + P(5, 8) + P(0, 8) + P(20, 8)
= .20 + .16 + .10 + .02
= .48
Some Basic Relationships of Probability
There are some basic probability relationships that
can be used to compute the probability of an event
without knowledge of all the sample point probabilities.
Complement of an Event
Union of Two Events
Intersection of Two Events
Mutually Exclusive Events
Complement of an Event
The complement of event A is defined to be the event
consisting of all sample points that are not in A.
The complement of A is denoted by Ac.
Sample
Event A Ac Space S
Venn
Diagram
Union of Two Events
The union of events A and B is the event containing
all sample points that are in A or B or both.
The union of events A and B is denoted by A B
Sample
Event A Event B Space S
Union of Two Events
Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M C = Markley Oil Profitable
or Collins Mining Profitable (or both)
M C = {(10, 8), (10, 2), (5, 8), (5, 2), (0, 8), (20, 8)}
P(M C) = P(10, 8) + P(10, 2) + P(5, 8) + P(5, 2)
+ P(0, 8) + P(20, 8)
= .20 + .08 + .16 + .26 + .10 + .02
= .82
Intersection of Two Events
The intersection of events A and B is the set of all
sample points that are in both A and B.
The intersection of events A and B is denoted by A
Sample
Event A Event B Space S
Intersection of A and B
Intersection of Two Events
Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M C = Markley Oil Profitable
and Collins Mining Profitable
M C = {(10, 8), (5, 8)}
P(M C) = P(10, 8) + P(5, 8)
= .20 + .16
= .36
Addition Law
The addition law provides a way to compute the
probability of event A, or B, or both A and B occurring.
The law is written as:
P(A B) = P(A) + P(B) P(A B
Addition Law
Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M C = Markley Oil Profitable
or Collins Mining Profitable
We know: P(M) = .70, P(C) = .48, P(M C) = .36
Thus: P(M C) = P(M) + P(C) P(M C)
= .70 + .48 .36
= .82
(This result is the same as that obtained earlier
using the definition of the probability of an event.)
Mutually Exclusive Events
Two events are said to be mutually exclusive if the
events have no sample points in common.
Two events are mutually exclusive if, when one event
occurs, the other cannot occur.
Sample
Event A Event B Space S
Mutually Exclusive Events
If events A and B are mutually exclusive, P(A B = 0.
The addition law for mutually exclusive events is:
P(A B) = P(A) + P(B)
There is no need to
include “ P(A B”
Conditional Probability
The probability of an event given that another event
has occurred is called a conditional probability.
The conditional probability of A given B is denoted
by P(A|B).
A conditional probability is computed as follows :
P( A B )
P( A|B)
P( B)
Conditional Probability
Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
P(C | M ) = Collins Mining Profitable
given Markley Oil Profitable
We know: P(M C) = .36, P(M) = .70
P(C M ) .36
Thus: P(C | M ) .5143
P( M ) .70
Multiplication Law
The multiplication law provides a way to compute the
probability of the intersection of two events.
The law is written as:
P(A B) = P(B)P(A|B)
Multiplication Law
Example: Bradley Investments
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
(This result is the same as that obtained earlier
using the definition of the probability of an event.)
Independent Events
If the probability of event A is not changed by the
existence of event B, we would say that events A
and B are independent.
Two events A and B are independent if:
P(A|B) = P(A) or P(B|A) = P(B)
Multiplication Law
for Independent Events
The multiplication law also can be used as a test to see
if two events are independent.
The law is written as:
P(A B) = P(A)P(B)
Multiplication Law
for Independent Events
Example: Bradley Investments
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
Are events M and C independent?
DoesP(M C) = P(M)P(C) ?
We know: P(M C) = .36, P(M) = .70, P(C) = .48
But: P(M)P(C) = (.70)(.48) = .34, not .36
Hence: M and C are not independent.
Mutual Exclusiveness and Independence
Do not confuse the notion of mutually exclusive
events with that of independent events.
Two events with nonzero probabilities cannot be
both mutually exclusive and independent.
If one mutually exclusive event is known to occur,
the other cannot occur.; thus, the probability of the
other event occurring is reduced to zero (and they
are therefore dependent).
Two events that are not mutually exclusive, might
or might not be independent.
Bayes’ Theorem
Often we begin probability analysis with initial or
prior probabilities.
Then, from a sample, special report, or a product
test we obtain some additional information.
Given this information, we calculate revised or
posterior probabilities.
Bayes’ theorem provides the means for revising the
prior probabilities.
Application
Prior New Posterior
of Bayes’
Probabilities Information Probabilities
Theorem
