Business Statistics

Fall, 2013 Probability

Lecture outline
Random experiment What is probability Sample space and events Probability Postulates Probability Rules

Suppose that a process that could lead to two or more different outcomes is to be observed, so there is uncertainty beforehand as to which outcome will occur. - A coin is thrown - A die is rolled - A consumer is asked which of two products she prefers - The daily change in an index of stock market prices is observed Each of these examples involves a random experiment.

Random Experiment A random experiment is a process leading to at least two possible outcomes with uncertainty as to which will occur.

 Language of probability helps us to make precise statements about the nature of our uncertainty.
Indeed, we can think of probability as the language in which we discuss uncertainty. We will now turn to develop a formal structure for making probability statements.

 What is probability? Subjective probability

Subjective probability is personal. Personal hunch, based on the knowledge or experience the person has and the way the person interprets it, his intuition.

Subjective probability
- Common form of probability in business and policymaking What is the probability our product will be successful in the market What is the probability that the S&P 500 price index will go up tomorrow Corporate executives face decisions as to whether to make potentially lucrative investments in countries that have unstable political climates. Either formally or informally, it is necessary to assess the likelihood of the nationalization of the corporations assets. Such assessment must surely be subjective. - Should be used with a high level of skepticism

Relative frequency interpretation of probability

Let N A be the number of occurrences of event A in N repeated trials (outcomes are not interdependent), Proportion of occurrences of event A in N trials = N A
N

Now suppose N becomes large

lim Probability that A occurs = N NA N

Relative frequency
Probability is viewed as a result of long-run convergence. In the short run as in a casino, we can see streaks of winning, but in the long run, with enough hands of blackjack, you should expect losses.

Classical interpretation of probability

- Very similar o the relative frequency view - Assumes all possible outcomes are equally likely to occur - Important idea: we can obtain a probability from a logical reasoning about the process, without performing the random experiments for a large number of times

Classical Probability that an event will occur

number of outcomes in the sample space that satisfy the event number of all possible outcomes in the sample space
Requirements: - can count the total number of possible outcomes in the sample space - can count the number of ways an event can occur

Lets define sample space and event

Basic Outcome a possible outcome of a random experiment Sample Space the collection of all possible outcomes of a random experiment Event any subset of basic outcomes from the sample space The null set (phi) - This is the empty set

 An example particularly relevant in Xiamen

Mid-Autumn Festival Xiamen Bo Bing Rolling six dice together and win soaps, tissues, and toothpastes Rolling six dice together, how many possible outcomes? S= {(1,2,3,4,5,6), (2,1,3,4,5,6), (3,2,1,4,5,6), (4,4,4,4,1,1), }

Actually 46656 possible outcomes. We will learn how to count the total number of possible outcomes later.

 Define event A = to get Winner Wearing Blossoms (four fours and two ones) when rolling six dice together.
A={(4,4,4,4,1,1), (4,1,1,4,4,4), (4,4,1,1,4,4), }

How many possible outcomes in this set? Actually 15. We will learn how to count the outcomes later.
So you see how hard it is to get Winner Wearing Blossoms? P(A) = 15/46656 = 0.000322 = 0.03% If there were items to give away but is marked for Winner Wearing Blossoms, sometimes people have to play long time to get the dice turn out the streak we want.

i.e., A B

Mutually Exclusive Events

Mutually exclusive events cannot logically happening at the same time. e.g., (i) A flipped coin coming up heads and the same coin coming up tails at the same time (ii) The two events it rained the whole day on Monday and it did not rain at all on Monday are mutually exclusive events Name a pair of mutually exclusive events to your neighbor!

 The classical thinking about the nature of light is the mutually exclusive way of thinking: if light is wave, light cant be particle. If light is particle, light cant be wave. A central concept of quantum mechanics: the paradoxical wave-particle duality however challenges the human mind. Quantum mechanics: light is wave, yes. Light is particle, yes. And this paradox is the fundamental property of the universe. Current scientific theory holds that all particles also have a wave nature and vice versa.
Since we are confined by space and time, we are inclined to look at things in a mutually exclusive way.

 Lets look at the events A and A complement

A A S A A
Notice that A an A complement are MECE (me-see), or mutually exclusive and collectively exhaustive.

 Lets do some quick practice to get familiar with the ideas of complement, intersection, and unions.

 A few rules with set operators

Probability and Its Postulates

 Some immediate consequences of the three postulates (i) If the sample space S consists of n equally likely basic outcomes, then each of these has probability 1/n; that is
P (Oi ) 1 n
This follows from the third postulate. If P(Oi) is the same for each basic outcome and the summation of the probabilities of all basic outcomes is equal to 1, then P(Oi) must be 1/n. For example, if a fair die is rolled, the probability for each of the six basic outcomes is 1/6.

(ii) If the sample space consists of n equally likely basic outcomes and the even A consists of nA of these outcomes, then
nA P ( A) n
This follows the second postulate and consequence (i). For example, if a fair die is rolled and A is the event Even number results, there are n=6 basic outcomes, and nA=3 of these are in A. Hence P(A)=3/6 =1/2.

(iii) Let A and B be mutually exclusive events. Then the probability of their union is the sum of their individual probabilities; that is
P ( A B ) P ( A) P ( B )

More generally, if E1, E2, , Ek are mutually exclusive events

P ( E1 E1 E K ) P ( E1 ) P ( E2 ) P( EK )

This result is a consequence of the second postulate. The probability of the union of A and B is

P( A B )

A B

P(O )
i

Where the summation extends over all the basic outcomes in the union of A and B. But since A and B are mutually exclusive, no basic outcome can belong to both, so the above formula can be broken down into the sum of two parts:
A B

P(O ) P(O ) P(O ) P( A) P( B)

i i i A B

(iv) If E1, E2, , Ek are collectively exhaustive events, the probability of their union is
P ( E1 E1 EK ) 1

Since the events are collectively exhaustive, their union is the whole sample space S, and the result follows from the third postulate.

Probability rules

 The rule of total probability

Class practice A hamburger chain found that 75% of all customers use mustard, 80% use ketchup, and 65% use both. What is the probability that a particular customer will use at least one of these?

 The union occurs if and only if either A or B or both occurs. The union is the set of all basic outcomes in S that belong to at least one of the two events A and B.