COMPLETE 2-1 fourth edi tion

BUSINESS STATISTICS

2 Probability

Using Statistics

Basic Definitions: Events, Sample Space, and
Probabilities

Basic Rules for Probability

Conditional Probability

Independence of Events

Combinatorial Concepts

The Law of Total Probability and Bayes’ Theorem

Summary and Review of Terms

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COMPLETE 2-2 fourth edi tion
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2-1 Probability is:


A 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%)

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Types of Probability (1)


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)
– examples: toss a coins, throw a die, pick a card

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Types of Probability (2)


Subjective Probability
– based on personal beliefs, experiences,
prejudices, intuition - personal judgment
– different for all observers (subjective)
– examples: Super Bowl, elections, new product
introduction, snowfall

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2-2 Basic Definitions (1)


Set - a collection of elements or objects of
interest
– Empty set (denoted by )

a set containing no elements
– Universal set (denoted by S)

a set containing all possible elements
– Complement (Not). The complement of A is  A 
– a set containing all elements of S not in A

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Basic Definitions (2)

– Intersection (And)  A  B
– a set containing all elements in both A and B
– Union (Or)  A  B

– a set containing all elements in A or B or

both

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Basic Definitions (3)

• Mutually exclusive or disjoint sets

–sets having no elements in common, having no
intersection, whose intersection is the empty set
• Partition
–a collection of mutually exclusive sets which
together include all possible elements, whose
union is the universal set

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Sets: Diagrams

A A A B
B A B
A

B
AA B BB
AA

A1 A3
A2

A4 A5

Partition

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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.

* Also called a basic outcome, elementary event, or simple event

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Events : Definition

Sample Space or Event Set
– Set of all possible outcomes (universal set) for a given
experiment

E.g.: Throw die
– S = (1,2,3,4,5,6)

Event
– Collection of outcomes having a common characteristic
 E.g.: Even number
– A = (2,4,6)
– Event A occurs if an outcome in the set A occurs
 Probability of an event
– Sum of the probabilities of the outcomes of which it
consists

P(A) = P(2) + P(4) + P(6)

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Equally-likely Probabilities
(Hypothetical or Ideal Experiments)
• For example:
– Throw a die
• Six possible outcomes (1,2,3,4,5,6)
• If each is equally-likely, the probability of each is 1/6 = .1667
= 16.67%
1
• P ( e ) 
n( S )
• Probability of each equally-likely outcome is 1 over the
number of possible outcomes
– Event A (even number)
• P(A) = P(2) + P(4) + P(6) = 1/6 + 1/6 + 1/6 = 1/2
• P( A)   P( e) for e in A
n( A ) 3 1
  
n( S ) 6 2

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Pick a Card: Sample Space

Hearts Diamonds Clubs Spades
A A A A
Union of K K K K
Event ‘Ace’
Events ‘Heart’ Q Q Q Q
J J J J n ( Ace ) 4 1
and ‘Ace’ 10 10 10 10
P ( Ace )   
P ( Heart  Ace )  n(S ) 52 13
9 9 9 9
8 8 8 8
n ( Heart  Ace ) 7 7 7 7
 6 6 6 6
n(S ) 5 5 5 5
4 4 4 4
16 4 3 3 3 3

2 2 2 2
52 13

The intersection of the

events ‘Heart’ and ‘Ace’
Event ‘Heart’
comprises the single point
n ( Heart ) 13 1
P ( Heart )    circled twice: the ace of hearts
n(S ) 52 4 n ( Heart  Ace ) 1
P ( Heart  Ace )  
n(S ) 52

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COMPLETE 2-13 fourth edi tion
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2-3 Basic Rules for Probability (1)

 Range of
Range of Values
Values 0  P( A)  1

 Complements -- Probability
Complements Probability of
of not
not A
A
P( A )  1  P( A)
 Intersection -- Probability
Intersection Probability of
of both
both A
A and
and BB
P( A  B)  n( A  B)
n( S )
–– Mutually
Mutuallyexclusive
exclusiveevents
events(A
(Aand
andC)
C)::
P( A  C )  0

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COMPLETE 2-14 fourth edi tion
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Basic Rules for Probability (2)

•• Union
Union--Probability
Probabilityof
ofAAor
orBBor
orboth
both

P( A  B)  n( A  B)  P( A)  P( B)  P( A  B)
n( S )

–– Mutually
Mutuallyexclusive
exclusiveevents:
events:
P( A  C)  0 so P( A  C)  P( A)  P(C)

•• Conditional
ConditionalProbability
Probability--Probability
Probabilityof
ofAAgiven
givenBB
P( A B)  P( A  B)
P( B)

P( A B)  P( A)
–– Independent
Independentevents:
events: P( B A)  P( B)

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COMPLETE 2-15 fourth edi tion
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2-4 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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COMPLETE 2-16 fourth edi tion
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Contingency Table (Example 2-2)

Counts
AT& T IBM Total

Telecommunication 40 10 50 Probability that a project

Computers 20 30 50
is undertaken by IBM
given it is a
Total 60 40 100
telecommunications
Probabilities project:
P ( IBM T )
AT& T IBM Total P ( IBM T ) 
P (T )
Telecommunication .40 .10 .50
.10
 .2
Computers .20 .30 .50 .50
Total .60 .40 1.00

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COMPLETE 2-17 fourth edi tion
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2-5 Independence of Events

Conditions for the statistical independence of events A and B:

P ( A B )  P( A)
P ( B A)  P( B )
and
P ( A  B )  P( A) P ( B )
P ( Ace  Heart ) P ( Heart  Ace )
P ( Ace Heart )  P ( Heart Ace ) 
P ( Heart ) P ( Ace )
1 1
1 1
 52   P ( Ace )  52   P ( Heart )
13 13 4 4
52 52
4 13 1
P ( Ace  Heart )    P ( Ace ) P ( Heart )
52 52 52

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COMPLETE 2-18 fourth edi tion
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Independence of Events (Example 2-5)

Events Television (T) and Billboard (B) are

assumed to be independent.

a) P (T  B )  P (T ) P ( B )
 0.04 * 0.06  0.0024
b) P (T  B )  P (T )  P ( B )  P (T  B)
 0.04  0.06  0.0024  0.0976

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Product Rules for Independent Events

The probability of the intersection of several independent events
is the product of their separate individual probabilities:
P( A  A  A  An )  P( A ) P( A ) P( A ) P( An )
1 2 3 1 2 3
The probability of the union of several independent events
is 1 minus the product of probabilities of their complements:
P( A  A  A  An )  1  P( A ) P( A ) P( A ) P( An )
1 2 3 1 2 3

Example 2-7:
(Q  Q  Q Q )  1 P(Q ) P(Q ) P(Q ) P(Q )
1 2 3 10 1 2 3 10
 1.9010  1.3487 .6513
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COMPLETE 2-20 fourth edi tion
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2-6 Combinatorial Concepts

Consider a pair of six-sided dice. There are six possible outcomes
from throwing the first die (1,2,3,4,5,6) and six possible outcomes
from throwing the second die (1,2,3,4,5,6). Altogether, there are
6*6=36 possible outcomes from throwing the two dice.
In general, if there are n events and the event i can happen in
Ni possible ways, then the number of ways in which the
sequence of n events may occur is N1N2...Nn.

Pick 5 cards from a deck of 52 - with 
Pick 5 cards from a deck of 52 - without
replacement replacement
– 52*52*52*52*52=525 380,204,032 different possible outcomes – 52*51*50*49*48 = 311,875,200 different possible outcomes

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COMPLETE 2-21 fourth edi tion
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More on Combinatorial Concepts

. .
(Tree Diagram)
Order the letters: A, B, and C
C

. .. ..
ABC
B
C B

. . . A ACB

..
A C BAC
B

. .
C A
C BCA

. .
A B
B CAB
A
CBA

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COMPLETE 2-22 fourth edi tion
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Factorial
How many ways can you order the 3 letters A, B, and C?
There are 3 choices for the first letter, 2 for the second, and 1 for
the last, so there are 3*2*1 = 6 possible ways to order the three
letters A, B, and C.

How many ways are there to order the 6 letters A, B, C, D, E,

and F? (6*5*4*3*2*1 = 720)

Factorial: For any positive integer n, we define n factorial as:

n(n-1)(n-2)...(1). We denote n factorial as n!.
The number n! is the number of ways in which n objects can
be ordered. By definition 1! = 1.

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COMPLETE 2-23 fourth edi tion
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Permutations
What if we chose only 3 out of the 6 letters A, B, C, D, E, and F?
There are 6 ways to choose the first letter, 5 ways to choose the
second letter, and 4 ways to choose the third letter (leaving 3
letters unchosen). That makes 6*5*4=120 possible orderings or
permutations.

Permutations are the possible ordered selections of r objects out

of a total of n objects. The number of permutations of n objects
taken r at a time is denoted nPr.
P  n!
n r ( n  r )!

For example:
6! 6! 6 * 5 * 4 * 3 * 2 * 1
P    6 * 5 * 4  120
(6  3)! 3! 3 * 2 *1
6 3

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COMPLETE 2-24 fourth edi tion
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Combinations
Suppose that when we picked 3 letters out of the 6 letters A, B, C, D, E, and F
we chose BCD, or BDC, or CBD, or CDB, or DBC, or DCB. (These are the
6 (3!) permutations or orderings of the 3 letters B, C, and D.) But these are
orderings of the same combination of 3 letters. How many combinations of 6
different letters, taking 3 at a time, are there?
Combinations are the possible selections of r items from a group of n items  n
regardless of the order of selection. The number of combinations is denoted  r
and is read n choose r. An alternative notation is nCr. We define the number
of combinations of r out of n elements as:
 n n!

  n rC 
 r r!(n  r)!
For example:
 n 6! 6! 6 * 5 * 4 * 3 * 2 * 1 6 * 5 * 4 120
   6 C3       20
 r 3!( 6  3)! 3!3! (3 * 2 * 1)( 3 * 2 * 1) 3 * 2 * 1 6

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COMPLETE 2-25 fourth edi tion
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Figure 2-10 Microsoft Excel
Spreadsheet
n=10(Total
n=10 (TotalNumber
NumberofofObjects
ObjectsAvailable)
Available)

TotalNumber
Total Numberofof ##ofof Probabilityofof
Probability ##ofof Probabilityofof
Probability
ObjectsSelected
Objects Selectedr r Permutations
Permutations Particular
ParticularPermutation
Permutation Combinations
Combinations Particular
ParticularCombination
Combination
11 10
10 0.1
0.1 10
10 0.1
0.1
22 90
90 0.011111111
0.011111111 45
45 0.022222222
0.022222222
33 720
720 0.001388889
0.001388889 120
120 0.008333333
0.008333333
44 5040
5040 0.000198413
0.000198413 210
210 0.004761905
0.004761905
55 30240
30240 3.31E-05
3.31E-05 252
252 0.003958254
0.003958254
66 151200
151200 6.61E-06
6.61E-06 210
210 0.004761905
0.004761905
77 604800
604800 1.65E-06
1.65E-06 120
120 0.008333333
0.008333333
88 1814400
1814400 5.51E-07
5.51E-07 45
45 0.022222222
0.022222222
99 3628800
3628800 2.76E-07
2.76E-07 10
10 0.1
0.1
10
10 3628800
3628800 2.76E-07
2.76E-07 11 11

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COMPLETE 2-26 fourth edi tion
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2-7 The Law of Total Probability and
Bayes’ Theorem

P( A)  P( A  B)  P( A  B )

In terms of conditional probabilities:

P( A)  P( A  B)  P( A  B )
 P( A B) P( B)  P( A B ) P( B )

More generally (where Bi make up a partition):

P( A)   P( A  B )
i
  P( AB ) P( B )
i i

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COMPLETE 2-27 fourth edi tion
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The Law of Total Probability
(Example 2-9)
Event U: Stock market will go up in the next year
Event W: Economy will do well in the next year
P(U W ) .75
P(U W )  30
P(W ) .80  P(W )  1.8 .2

P(U )  P(U W )  P(U W )

 P(U W ) P(W )  P(U W ) P(W )
 (.75)(.80)  (.30)(.20)
.60.06 .66

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COMPLETE 2-28 fourth edi tion
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Bayes’ Theorem
• Bayes’ theorem enables you, knowing just a little more
than the probability of A given B, to find the
probability of B given A.
• Based on the definition of conditional probability and
the law of total probability.
P ( A B)
P ( B A) 
P ( A)
P ( A B) Applying the law of total
 probability to the denominator
P ( A B)  P ( A B )
P ( A B) P ( B) Applying the definition of

P ( A B ) P ( B)  P ( A B ) P ( B ) conditional probability throughout

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COMPLETE 2-29 fourth edi tion
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Bayes’ Theorem (Example 2-10)

• A medical test for a rare disease (affecting 0.1% of the

population [ P ( I )  0.001 ]) is imperfect:
– When administered to an ill person, the test will indicate so
with probability 0.92 [ P( Z I ) .92  P ( Z I ) .08 ]
• The event ( Z I ) is a false negative
– When administered to a person who is not ill, the test will
erroneously give a positive result (false positive) with
probability 0.04 [ P ( Z I )  0.04  P ( Z I )  0.96 ]
• The event ( Z I ) is a false positive. .

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Example 2-10 (continued)

P ( I )  0.001 P( I Z ) 
P ( I Z )
P( Z )
P ( I Z )

P ( I )  0.999 P ( I Z )  P ( I Z )
P( Z I ) P( I )

P( Z I ) P( I )  P( Z I ) P( I )
P ( Z I )  0.92 
(.92)( 0.001)
(.92)( 0.001)  ( 0.04)(.999)
0.00092 0.00092
 
P ( Z I )  0.04 0.00092  0.03996 .04088
.0225

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COMPLETE 2-31 fourth edi tion
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Example 2-10 (Tree Diagram)

Prior Conditional Joint
Probabilities Probabilities Probabilities

P( Z I )  0.92 P( Z  I )  (0.001)(0.92) .00092

P ( Z I )  0.08 P ( Z  I )  (0.001)(0.08) .00008

P( I )  0.001

P ( I )  0.999 P( Z I )  0.04 P ( Z  I )  (0.999)(0.04) .03996

P ( Z I )  0.96

P ( Z  I )  (0.999)(0.96) .95904

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COMPLETE 2-32 fourth edi tion
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Bayes’ Theorem Extended

• Given a partition of events B1,B2 ,...,Bn:

P( A  B )
P ( B A)  1

P ( A)
1

Applying the law of total

P( A  B ) probability to the denominator
 1

 P( A  B ) i
Applying the definition of
P( A B ) P( B ) conditional probability throughout
 1 1

 P( A B ) P( B )
i i

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COMPLETE 2-33 fourth edi tion
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Bayes’ Theorem Extended
(Example 2-11)

An economist believes that during periods of high economic growth, the U.S.
dollar appreciates with probability 0.70; in periods of moderate economic
growth, the dollar appreciates with probability 0.40; and during periods of
low economic growth, the dollar appreciates with probability 0.20.

During any period of time, the probability of high economic growth is 0.30,
the probability of moderate economic growth is 0.50, and the probability of
low economic growth is 0.50.

Suppose the dollar has been appreciating during the present period. What is
the probability we are experiencing a period of high economic growth?
Partition: Event A  Appreciation
H - High growth P(H) = 0.30 P( A H )  0.70
M - Moderate growth P(M) = 0.50 P( A M )  0.40
L - Low growth P(L) = 0.20 P( A L)  0.20

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Example 2-11 (continued)

P( H  A)
P( H A) 
P ( A)
P ( H  A)

P( H  A)  P( M  A)  P ( L  A)
P( A H ) P( H )

P ( A H ) P ( H )  P ( A M ) P ( M )  P ( A L) P ( L)
( 0.70)( 0.30)

( 0.70)( 0.30)  ( 0.40)( 0.50)  ( 0.20)( 0.20)
0.21 0.21
 
0.21 0.20  0.04 0.45
 0.467

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COMPLETE 2-35 fourth edi tion
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Example 2-11 (Tree Diagram)

Prior Conditional Joint
Probabilities Probabilities Probabilities
P ( A H )  0.70 P ( A  H )  ( 0.30)( 0.70)  0.21

P ( A H )  0.30
P ( H )  0.30 P ( A  H )  ( 0.30)( 0.30)  0.09

P ( A M )  0.40 P ( A  M )  ( 0.50)( 0.40)  0.20

P ( M )  0.50

P ( A M )  0.60 P ( A  M )  ( 0.50)( 0.60)  0.30

P ( A L )  0.20
P ( L )  0.20 P ( A  L )  ( 0.20)( 0.20)  0.04

P ( A L )  0.80 P ( A  L )  ( 0.20)( 0.80)  0.16

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