.

..
. SLIDES . BY
.. John Loucks
.
.. St. Edward’s
.. University

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 Chapter 4
Introduction to Probability
 Experiments, Counting Rules,
and Assigning Probabilities
 Events and Their Probability
 Some Basic Relationships
of Probability
 Conditional Probability
 Bayes’ Theorem

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 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?

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Uncertainties

In most business situations we cannot be

certain about the occurrence of a future
event, but if the probability of the event is
known, then we have a better chance of
making the best possible decision,
compared to having no idea about the likely
occurrence of the event. Business decisions
and policies are often based on an implicit or
assumed set of probabilities.

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 Examples

1. A coin is tossed and the outcome is either a head or a tail.

2. A company has the possibility of receiving contract
awards.
3. The number of persons admitted to a hospital emergency
room during any hour cannot be known in advance.
4. A customer enters a store and either purchases a shirt or
does not.
5. The daily change in an index of stock market prices is
observed.
6. A bag of cereal is selected from a packaging line and
weighed to determine if the weight is above or below the
stated package weight.

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 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.

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Probability as a Numerical Measure
of the Likelihood of Occurrence
Increasing Likelihood of Occurrence

0 . 1
Probability 5
:
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.

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Statistical Experiments

In statistics, the notion of an experiment differs

somewhat from that of an experiment in the
physical sciences.

In statistical experiments, probability determines

outcomes.

Even though the experiment is repeated in exactly

the same way, an entirely different outcome may
occur.

For this reason, statistical experiments are some-

times called random experiments.
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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.

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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 Investment Gain or Loss
from now are in
as 3follows.
Months (in $1000s)
Markley Oil Collins Mining
10 8
5 -2
0
-20
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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-step
experiment is a tree diagram.

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Tree Diagram
 Example: Bradley Investments
Markley Oil Collins Mining Experimental
(Stage 1) (Stage 2) Outcomes
Gain 8 (10, 8) Gain $18,0
(10, -2) Gain $8,0
Gain 10 Lose 2
Gain 8 (5, 8) Gain $13,000
(5, -2) Gain $3,0
Gain 5 Lose 2
Gain 8
(0, 8) Gain $8,0
Even
(0, -2) Lose $2,0
Lose 20 Lose 2
Gain 8 (-20, 8) Lose $12,0
Lose 2 (-20, -2) Lose $22,0
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Counting Rule for Combinations

 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 N
from
 a set
N ! of N objects.
N
Cn   
 n  n!(N  n)!

where: N! = N(N - 1)(N - 2) . . . (2)(1)

n! = n(n - 1)(n - 2) . . . (2)(1)
0! = 1

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Assigning Probabilities

 Basic Requirements for Assigning Probabilities

1. The probability assigned to each experimental

outcome must be between 0 and 1, inclusively.

0 < P(Ei) < 1 for all i

where:
Ei is the ith experimental outcome
and P(Ei) is its probability

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Assigning Probabilities

 Basic Requirements for Assigning Probabilities

2. The sum of the probabilities for all experimenta

outcomes must equal 1.

P(E1) + P(E2) + . . . + P(En) = 1

where:
n is the number of experimental outcomes

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Classical Method

 Example: Rolling a Die

If an experiment has n possible
outcomes, the
classical method would assign a probability
of 1/n
Experiment:
to Rolling a die
each outcome.
Sample Space: S = {1, 2, 3, 4, 5, 6}
Probabilities: Each sample point has a
1/6 chance of occurring

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

Number of Number
daily Polishers Rented of Days
rentals for the last
0 40 days. 4
1 6
2 18
3 10
4 2
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Relative Frequency Method

 Example: Lucas Tool Rental

Each probability assignment is given by
dividing
the frequency (number of days) by the total
frequency
Numberof
(total number ofdays).
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
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Subjective Method

 When economic conditions or 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 probabilit
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.

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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
1.00
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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.

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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 theofsample
Complement point
an Event
probabilities.
Union of Two Events

Intersection of Two Events

Mutually Exclusive Events

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Complement of an Event

The complement of event A is defined to be the even

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
Diagra
m
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Addition Law

The addition law provides a way to compute the

probability of event A, or B, or both A and B occurrin

The law is written as:

P(A B) = P(A) + P(B) - P(A  B

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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.)
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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 even

occurs, the other cannot occur.

Sample
Event A Event B Space S

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Mutually Exclusive Events

If events A and B are mutually exclusive, P(A  B =

The addition law for mutually exclusive events is:

P(A B) = P(A) + P(B)

There is no need to
include “- P(A  B”

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Conditional Probability

The probability of an event given that another even

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)

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Multiplication Law

The multiplication law provides a way to compute th

probability of the intersection of two events.

The law is written as:

P(A B) = P(B)P(A|B)

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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.)
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Joint Probability Table

Collins Mining
Markley Oil Profitable (C) Not Profitable (Cc) Total

Profitable (M) .36 .34 .70

Not Profitable (Mc) .12 .18 .30

Total .48 .52 1.00

Joint Probabilities
(appear in the
Marginal Probabilities
body
(appear in the
of the table)
margins
of the table)
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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)

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Multiplication Law
for Independent Events
The multiplication law also can be used as a test to
if two events are independent.

The law is written as:

P(A B) = P(A)P(B)

© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 Multiplication Law
for Independent Events
 Example: Bradley Investments

Event M = Markley Oil Profitable

Event C = Collins Mining Profitable
Are events M and C independent?
DoesP(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.

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or duplicated, or posted to a publicly accessible website, in whole or in part.
 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.
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or duplicated, or posted to a publicly accessible website, in whole or in part.
 End of Chapter 4

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or duplicated, or posted to a publicly accessible website, in whole or in part.