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Chapter 5
A PowerPoint Presentation Package to Accompany
Probability
Chapter Contents
Applied Statistics in Business &
Economics, 4th edition 5.1 Random Experiments
5.2 Probability
David P. Doane and Lori E. Seward 5.3 Rules of Probability
5.4 Independent Events
5.5 Contingency Tables
Prepared by Lloyd R. Jaisingh
5.6 Tree Diagrams
5.7 Bayes Theorem
5.8 Counting Rules
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 5-2

Chapter 5

Chapter 5
Probability Probability
Chapter Learning Objectives Chapter Learning Objectives

LO5-1: Describe the sample space of a random variable. LO5-6: Apply the concepts of probability to contingency tables.
LO5-2: Distinguish among the three views of probability. LO5-7: Interpret a tree diagram.
LO5-3: Apply the definitions and rules of probability. LO5-8: Use Bayes Theorem to calculate revised probabilities.
LO5-4: Calculate odds from given probabilities. LO5-9: Apply counting rules to calculate possible event arrangements.
LO5-5: Determine when events are independent.

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Chapter 5

Chapter 5

LO5-1 5.1 Random Experiments LO5-1 5.1 Random Experiments

LO5-1: Describe the sample space of a random experiment. Sample Space
•  For a single roll of a die, the sample space is:
Sample Space

•  A random experiment is an observational process whose results •  When two dice are rolled, the sample space is the following
cannot be known in advance. pairs:
•  The set of all outcomes (S) is the sample space for the experiment.

•  A sample space with a countable number of outcomes is discrete.

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Chapter 5

Chapter 5
LO5-1 5.1 Random Experiments LO5-1 5.1 Random Experiments
Sample Space Events
•  If the outcome is a continuous measurement, the sample space •  An event is any subset of outcomes in the sample space.
cannot be listed but can be described by a rule.

•  For example, the sample space for the length of a randomly chosen •  A simple event or elementary event, is a single outcome.
cell phone call would be
•  A discrete sample space S consists of all the simple events (Ei):
S = {all X such that X > 0}. S = {E1, E2, …, En}.
•  For example, Amazon s website for Books & Music
•  The sample space to describe a randomly chosen student s GPA
has seven categories that a shopper might choose:
would be

S = {all X such that 0.00 ≤ X ≤ 4.00}. S = {Books, DVD, VHS, Magazines, Newspapers,
Music, Textbooks}.

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Chapter 5

Chapter 5
LO5-1 5.1 Random Experiments LO5-2 5.2 Probability
Events LO5-2: Distinguish among the three views of probability.
Within this sample space, we could define compound events
electronic media as A = {Music, DVD, VHS} and print periodicals Definitions
as B = (Newspapers, Magazines}. This can be shown in a Venn •  The probability of an event is a number that measures the relative
diagram. likelihood that the event will occur.
•  The probability of event A [denoted P(A)] must lie within the interval
from 0 to 1:
0 ≤ P(A) ≤ 1

If P(A) = 0, then the If P(A) = 1, then the event

event cannot occur. is certain to occur.

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Chapter 5

Chapter 5

LO5-2 5.2 Probability LO5-2 5.2 Probability

Definitions Empirical Approach
•  In a discrete sample space, the probabilities of all simple events •  Use the empirical or relative frequency approach to assign
must sum to one: probabilities by counting the frequency (fi) of observed outcomes
P(S) = P(E1) + P(E2) + … + P(En) = 1 defined on the experimental sample space.

•  For example, if on a shopping spree, the following percentages (on

the left) were recorded for the four methods of payments. We can
compute the equivalent probabilities which sum to 1. •  For example, to estimate the default rate on student loans:
credit card: 32% P(credit card) = .32
debit card: 15% P(debit card) = .15
Probability P(a student defaults) = f /n = number of defaults
cash: 35% P(cash) = .35 number of loans
check: 18% P(check) = .18
Sum = 100% Sum = 1.0

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Chapter 5

Chapter 5
LO5-2 5.2 Probability LO5-2 5.2 Probability
Law of Large Numbers Law of Large Numbers
The law of large numbers says that as the number of trials increases,
any empirical probability approaches its theoretical limit.

•  Flip a coin 50 times. We would expect the proportion of heads to be

near .50.

•  However, in a small finite sample, any ratio can be obtained (e.g.,

1/3, 7/13, 10/22, 28/50, etc.).

•  A large n may be needed to get close to .50.

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Chapter 5

Chapter 5
LO5-2 5.2 Probability LO5-2 5.2 Probability
Classical Approach Classical Approach
•  For example, the two-dice experiment has 36 equally likely simple
•  A priori refers to the process of assigning probabilities before the events. The P(that the sum of the dots on the two faces equals 7)
event is observed or the experiment is conducted. is
•  A priori probabilities are based on logic, not experience.
•  When flipping a coin or rolling a pair of dice, we do not actually
have to perform an experiment because the nature of the process
allows us to envision the entire sample space.
•  Instead of performing the experiment, we can use deduction to •  The probability is
determine the probability of an event. obtained a priori using
the classical approach
•  This is the classical approach to probability. as shown in this Venn
diagram for 2 dice:

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Chapter 5

Chapter 5

LO5-2 5.2 Probability LO5-3 5.3 Rules of Probability

Subjective Approach LO5-3: Apply the definitions and rules of probability.
•  A subjective probability reflects someone s informed judgment
about the likelihood of an event. Complement of an Event
•  Used when there is no repeatable random experiment. •  The complement of an event A is denoted by
A′ and consists of everything in the sample space S except event A.
•  For example,
- What is the probability that a new truck
product program will show a return on •  Since A and A′ together
investment of at least 10 percent? comprise the entire sample
- What is the probability that the price of Ford s space,
stock will rise within the next 30 days? P(A) + P(A′ ) = 1 or P(A′ ) =
1 – P(A)

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Chapter 5

Chapter 5
LO5-3 5.3 Rules of Probability LO5-3 5.3 Rules of Probability
Union of Two Events Intersection of Two Events
(Figure 5.5)
•  The intersection of two events A and B
•  The union of two events consists of all outcomes in the sample (denoted by A ! B or A and B ) is the event consisting of all
space S that are contained either in event A or in event B or in both outcomes in the sample space S that are contained in both event A
(denoted A ! B or A or B ). and event B.

! may be read as ! may be read as

or since one or the and since both
other or both events events occur. This is
may occur. a joint probability.

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Chapter 5

Chapter 5
LO5-3 5.3 Rules of Probability LO5-3 5.3 Rules of Probability
General Law of Addition General Law of Addition
•  The general law of addition states that the probability of the union of •  For a standard deck of cards:
two events A and B is:
P(Q) = 4/52 (4 queens in a deck; Q = queen)
P(A ! B) = P(A) + P(B) – P(A ! B) P(R) = 26/52 (26 red cards in a deck; R = red)
P(Q ! R) = 2/52 (2 red queens in a deck)

When you add the P A and B So, you have to P(Q ! R) = P(Q) + P(R) – P(Q ! R)
(A) and P(B) subtract
together, you count P(A ! B) to avoid Q and R = 2/52 = 4/52 + 26/52 – 2/52
the P(A and B) A B overstating the
twice. probability. = 28/52 = .5385 or 53.85%
Q R
4/52 26/52

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Chapter 5

Chapter 5

LO5-3 5.3 Rules of Probability LO5-3 5.3 Rules of Probability

Mutually Exclusive Events Collectively Exhaustive Events
•  Events A and B are mutually exclusive (or disjoint) if their •  Events are collectively exhaustive if their union is the entire sample
intersection is the null set (!) which contains no elements. space S.

If A ! B = !, then P(A ! B) = 0 •  Two mutually exclusive, collectively exhaustive events are

dichotomous (or binary) events.
Special Law of Addition
For example, a car repair is
•  In the case of mutually either covered by the warranty
exclusive events, the (A) or not (A ).
addition law reduces to:
Note: This concept can be
P(A ! B) = P(A) + P(B) extended to more than two
No events. See the next slide
Warranty
Warranty
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Chapter 5

Chapter 5
LO5-3 5.3 Rules of Probability LO5-3 5.3 Rules of Probability
Collectively Exhaustive Events Conditional Probability
There can be more than two mutually exclusive, collectively exhaustive
events, as illustrated below. For example, a Walmart customer can pay •  The probability of event A given that event B has occurred.
by credit card (A), debit card (B), cash (C), or
check (D).
•  Denoted P(A | B).
The vertical line | is read as given.

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Chapter 5

Chapter 5
LO5-3 5.3 Rules of Probability LO5-3 5.3 Rules of Probability
Conditional Probability
•  Consider the logic of this formula by looking at the Venn diagram.
Example: High School Dropouts
The sample space is restricted to
B, an event that has occurred. •  Of the population aged 16–21 and not in college:

Unemployed 13.5%
A ! B is the part of B that is also High school dropouts 29.05%
in A.
Unemployed high school dropouts 5.32%
The ratio of the relative size of
A ! B to B is P(A | B). •  What is the conditional probability that a member of this population
is unemployed, given that the person is a high school dropout?

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Chapter 5

Chapter 5

LO5-3 5.3 Rules of Probability LO5-4 5.3 Rules of Probability

Example: High School Dropouts
LO5-4: Calculate odds from given probabilities
•  First define
U = the event that the person is unemployed
Odds of an Event
D = the event that the person is a high school dropout
•  The odds in favor of event A occurring are
P(U) = .1350 P(D) = .2905 P(U!D) = .0532

•  The odds against event A occurring are

•  P(U | D) = .1831 > P(U) = .1350

•  Therefore, being a high school dropout is related to being

unemployed.
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Chapter 5

Chapter 5
LO5-4 5.3 Rules of Probability LO5-5 5.4 Independent Events
Odds of an Event LO5-5: Determine when events are independent
•  If the odds against event A are quoted as b to a, then the implied
probability of event A is: •  Event A is independent of event B if the conditional probability P
(A | B) is the same as the marginal probability P(A).

•  P(U | D) = .1831 > P(U) = .1350, so U and D are not independent.

That is, they are dependent.

•  For example, if a race horse has a 4 to 1 odds against winning, the •  Another way to check for independence: Multiplication Law
P(win) is
If P(A ! B) = P(A)P(B) then event A is independent of event B
since
P( A ∩ B) P( A) × P( B)
P( A | B) = = = P( A)
P( B) P( B)

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Chapter 5

Chapter 5
LO5-5 5.4 Independent Events LO5-5 5.4 Independent Events
Application of the Multiplication Law (for Independent Events) Application of the Multiplication Law (for Independent Events)
•  The probability of n independent events occurring simultaneously is:
•  Applying the rule of independence:
P(A1 ! A2 ! ... ! An) = P(A1) P(A2) ... P(An)
if the events are independent P(F1 ! F2 ) = P(F1) P(F2) = (.01)(.01) = .0001

•  To illustrate system reliability, suppose a website has 2 independent •  So, the probability that both servers are down is .0001.
file servers. Each server has 99% reliability. What is the total
system reliability? Let
•  The probability that one or both servers is up is:

F1 be the event that server 1 fails

F2 be the event that server 2 fails 1 - .0001 = .9999 or 99.99%

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Chapter 5

Chapter 5

LO5-6 5.5 Contingency Table LO5-6 5.5 Contingency Table

LO5-6: Apply the concepts of probability to contingency tables. Example: Salary Gains and MBA Tuition
Example: Salary Gains and MBA Tuition
•  Are large salary gains more likely to accrue to graduates of high-
•  Consider the following cross-tabulation (contingency) table for n = tuition MBA programs?
67 top-tier MBA programs:
•  The frequencies indicate that MBA graduates of high-tuition
schools do tend to have large salary gains.

•  Also, most of the top-tier schools charge high tuition.

•  More precise interpretations of these data can be made using the

concepts of probability.

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Chapter 5

Chapter 5
LO5-6 5.5 Contingency Table LO5-6 5.5 Contingency Table
Marginal Probabilities Marginal Probabilities
•  The marginal probability of a single event is found by dividing a row •  Find the marginal probability of a low tuition P(T1).
or column total by the total sample size.

•  For example, find the marginal

probability of a medium salary gain (P(S2).

P(S2) = 33/67 = .4925

•  Conclude that about 49% of salary gains at the top-tier schools P(T1) = 16/67 = .2388
were between $50,000 and $100,000 (medium gain).
•  There is a 24% chance that a top-tier school s MBA tuition is under
$40,000.
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Chapter 5

Chapter 5
LO5-6 5.5 Contingency Table LO5-6 5.5 Contingency Table
Joint Probabilities Conditional Probabilities
•  A joint probability represents the intersection of two events in a cross- •  Find the probability that the salary gains are small (S1) given that
tabulation table. the MBA tuition is large (T3).
•  Consider the joint event that the school has P(T3 | S1) = 5/32 = .1563
low tuition and large salary gains
(denoted as P(T1 ! S3)).
Independence
P(T1 ! S3) = 1/67 = .0149
Conditional Marginal

•  There is less than a 2% chance that a top-tier school has both low P(S3 | T1)= 1/16 = .0625 P(S3) = 17/67 = .2537
tuition and large salary gains.
•  (S3) and (T1) are dependent.

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Chapter 5

Chapter 5

LO5-6 5.5 Contingency Table LO5-7 5.6 Tree Diagrams

Relative Frequencies LO5-7: Interpret a tree diagram.
• 
Here are the resulting probabilities (relative frequencies). Each What is a Tree?
value is divided by 67. For example,
P(T1 and S1) = 5/67 •  A tree diagram or decision tree helps you visualize all possible
P(T2 and S2) = 11/67 P(T3 and S3) = 15/67
outcomes.
•  Start with a contingency table.
P(S1) = 17/67 P(T2) = 19/67
•  For example, this table gives expense ratios by fund type for 21 bond
funds and 23 stock funds.

•  The tree diagram shows all events along with their marginal,
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Chapter 5

Chapter 5
LO5-7 5.6 Tree Diagrams LO5-8 5.7 Bayes Theorem
Tree Diagram for Fund Type and Expense Ratios LO8: Use Bayes Theorem to compute revised probabilities
•  Thomas Bayes (1702-1761) provided a method (called Bayes Theorem) of
revising probabilities to reflect new probabilities.
•  The prior (marginal) probability of an event B is revised after event A has
been considered to yield a posterior (conditional) probability.

•  Bayes s formula is:

•  In some situations P(A) is not given. Therefore, the most useful and
common form of Bayes Theorem is:

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Chapter 5

Chapter 5
LO5-8 5.7 Bayes Theorem LO5-8 5.7 Bayes Theorem
General Form of Bayes Theorem Example: Hospital Trauma Centers
(Table 5.18)
•  A generalization of Bayes s Theorem allows event B to have as many •  Based on historical data, the percent of cases at 3 hospital trauma
mutually exclusive and collectively exhaustive categories as we wish
centers and the probability of a case resulting in a malpractice suit
(B1, B2, …, Bn) rather than just two dichotomous categories (B and B').
are as follows:

•  Let event A = a malpractice suit is filed

Bi = patient was treated at trauma center i

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Chapter 5

Chapter 5

LO5-8 5.7 Bayes Theorem LO5-8 5.7 Bayes Theorem

Example: Hospital Trauma Centers Example: Hospital Trauma Centers

•  Applying the general form of Bayes Theorem, find P(B1 | A). •  Conclude that the probability that the malpractice suit was filed in
hospital 1 is .1389, or 13.89%.

•  All the posterior probabilities for each hospital can be calculated

and then compared:

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Chapter 5

Chapter 5
LO5-9 5.8 Counting Rules LO5-9 5.8 Counting Rules
LO9: Apply counting rules to calculate possible event arrangements. Example: Stockkeeping Labels

Fundamental Rule of Counting •  For example, AF1078: hex-head 6 cm bolts – box of 12;
RT4855: Lime-A-Way cleaner – 16 ounce LL3319: Rust-Oleum
•  If event A can occur in n1 ways and event B can occur in n2 ways,
primer – gray 15 ounce
then events A and B can occur in n1 x n2 ways.
•  There are 26 x 26 x 10 x 10 x 10 x 10 = 6,760,000 unique inventory
•  In general, m events can occur labels.
n1 x n2 x … x nm ways.

Example: Stockkeeping Labels

•  How many unique stockkeeping unit (SKU) labels can a hardware
store create by using two letters (ranging from AA to ZZ) followed
by four numbers (0 through 9)?

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Chapter 5

Chapter 5
LO5-9 5.8 Counting Rules LO5-9 5.8 Counting Rules
Factorials Permutations
•  The number of ways that n items can be arranged in a particular •  A permutation is an arrangement in a particular order of r randomly
order is n factorial. sampled items from a group of n items and is denoted by nPr
•  n factorial is the product of all integers from 1 to n.

n! = n(n–1)(n–2)...1
•  Factorials are useful for counting the possible arrangements of any •  In other words, how many ways can the r items be arranged from n
n items. items, treating each arrangement as different (i.e., XYZ is different
•  There are n ways to choose the first, n-1 ways to choose the from ZYX)?
second, and so on.

•  A home appliance service truck must make 3 stops (A, B, C). In

how many ways could the three stops be arranged?
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Chapter 5

LO5-9 5.8 Counting Rules

Combinations
•  A combination is an arrangement of r items chosen at random from
n items where the order of the selected items is not important (i.e.,
XYZ is the same as ZYX).
•  A combination is denoted nCr

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