Chap 5-1

Discrete Random Variables & Probability

Distributions

Notes adapted from Newbold et al. (2007)
Business Statistics

Chap 5-2
Concept of a random variable
A random variable X is a function that allocates
a numerical values to the outcome of a random
experiment.
Chap 5-3 Chap 5-3
Example
2 balls are drawn in succession without replacement
from an urn containing 4 red balls and 3 black balls.
The possible outcomes and the values x of the
random variable X, where X = # of red balls, are

sample space x
red, red 2
red, black 1
black, red 1
black, black 0
outcome Numerical
value
Discrete
random
variable
Chap 5-4 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 5-4

Random
Variables
Discrete
Random Variable
Continuous
Random Variable
Heights, weights,
temperatures, distance,
income, change in the price
of a share in a month, etc.
Number of insurance claims
within a year, number of
customers within an hour
Probability
statements
can be made
about
individual
possible
outcomes

Probability
of any
individual
outcome is 0
Chap 5-5
The distinction between discrete and continuous
random variables may appear rather artificial.

Rarely anything is actually measured on a continuum.

But when measurements can be made on such a fine
scale that differences between adjacent values are of
no significance, it is convenient to act as if they had
truly been made on a continuum.

For practical purposes, we will treat as discrete all
random variables for which probability statements about
the individual possible outcomes have worthwhile
meaning; all other random variables will be regarded as
continuous.
Chap 5-6 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 5-6
Probability Distribution Function
It is convenient to represent all the probabilities of
a random variable X by a formula f(x), where f(x) =
P(X=x). The function f(x) is called the probability
distribution function

The probability distribution function of a discrete r.v.
must satisfy two properties:
1. 0s f(x) s1 for any value x
2.
( ) 1
x
f x =

Chap 5-7 Chap 5-7

Recall the previous example
2 balls are drawn in succession without replacement
from an urn containing 4 red balls and 3 black balls.
The possible outcomes and the values x of the
random variable X, where X = # of red balls, are


sample space
(s)
x
red, red 2
red, black 1
black, red 1
black, black 0
x P(X=x) = f(x)
0 ?
1 ?
2 ?
Probability distribution function of
a discrete variable X
Chap 5-8 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 5-8
Example (Discrete r.v.)
A shipment of 8 similar chips contains 3 that are defective. If one
purchases 2 of these chips, find the probability distribution for the
number of defectives.




Chap 5-9 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 5-9
Example (Discrete r.v.)
A shipment of 8 similar chips contains 3 that are defective. If one
purchases 2 of these chips, find the probability distribution for the
number of defectives.
Let X=# of defectives purchased, so
x=0, 1, 2
And what about f(0), f(1), f(2)?
So the probability distribution of X is:

The probability distribution function can be written as:



x f(x)
0 10/28
1 15/28
2 3/28
3 5
2
8
2
( ) , 0,1, 2
x x
C C
f x x
C

= =
Chap 5-10 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 5-10
Cumulative Probability Function
The cumulative probability function F(x
0
) of a
discrete random variable X with probability
distribution function f(x) is:
F(x
0
) = P(X sx
0
) =
0
( )
x x
f x
s

Relationship between probability function and

cumulative probability function
Note: the event X sx
0
is the union of the m.e. events X=x
for xsx
0.

Chap 5-11
The properties of cumulative probability
function of a discrete r.v.:
1. 0s F(x
0
) s1 for every number x
0
2. If x
0
< x
1
, then F(x
0
) s F(x
1
)



Chap 5-12
The number of Iphone 5 sold per day at an Apple store is defined
by the following probability distribution, find the cumulative
probability distribution.






















X 0 1 2 3 4 5 6
f(x) 0.05 0.10 0.20 0.20 0.20 0.15 0.10
F(x)
What is F(2.5)?
What is F(7)?
Chap 5-13
The number of Iphone 5 sold per day at an Apple store is defined
by the following probability distribution, find the cumulative
probability distribution.






















X 0 1 2 3 4 5 6
f(x) 0.05 0.10 0.20 0.20 0.20 0.15 0.10
F(x) 0.05 0.15 0.35 0.55 0.75 0.90 1
0 if - < 0
0.05 if 0 1
0.15 if 1 2
0.35 if 2 3
( )
0.55 if 3 4
0.75 if 4 5
0.9 if 5 6
1 if 6
x
x
x
x
F x
x
x
x
x
<

s <

s <

s <

=

s <

s <

s <

s <

What is F(2.5)?
What is F(7)?
a) F(x) is defined for
all values of x,
F(2.5)=0.35.
b) F(x)=1 for x>6
Chap 5-14
Numerical Summary Measures of the
characteristics of a probability distribution
1. The expected value of a random variable
- measure of the center of a
probability distribution

2. The variance of a random variable

Chap 5-15
Expected Value (discrete)
Expected Value (or mean) of a discrete
distribution (average weighted according to the prob. dist.)




Example: Toss 2 coins,
x = # of heads,
compute expected value of x:
x P(x)

x
E(X) xP(x)
X
= =

Chap 5-16
Expected Value (discrete)
Expected Value (or mean) of a discrete
distribution (average weighted according to the prob. dist.)




Example: Toss 2 coins,
x = # of heads,
compute expected value of x:
E(X) = (0 x .25) + (1 x .50) + (2 x .25)
= 1.0
x P(x)
0 .25
1 .50
2 .25
x
E(X) xP(x)
X
= =

Chap 5-17
Let's play!
Who wants to be a millionaire?
A Chinese Version:
Chap 5-18
You have won $64,000 and are facing a tough
$125,000 question.

This means that you will receive $125,000 if you
answer the question correctly. But you will receive
only $32,000 if your answer is wrong. Also, you can
walk away with $64,000 if you decide not to answer
the question.

What would be the best strategy to take?
Game Situation
Chap 5-19
$125,000 Question
Which city is the birthplace of the famous
business math instructor Shuzo?
A. Wakayama B. Iiyama
C. Kumayama D. Matsuyama
Chap 5-20
Suppose that you decide to answer the question.
What is the expected value of the outcome?

Do you answer the question or do you walk
away with $64,000?
$125,000 Question
Which city is the birthplace of the famous
business math instructor Shuzo?
A. Wakayama B. Iiyama
C. Kumayama D. Matsuyama
Chap 5-21
Expected Value
125,000 1/4 + 32,000 3/4 = 55,250

Walk Away
64,000
$125,000 Question
Which city is the birthplace of the famous
business math instructor Shuzo?
A. Wakayama B. Iiyama
C. Kumayama D. Matsuyama
Chap 5-22
50:50
$125,000 Question
Which city is the birthplace of the famous
business math instructor Shuzo?
A. Wakayama B. Iiyama
C. Kumayama D. Matsuyama
Chap 5-23
B. Iiyama
C. Kumayama
Two
Choices
Chap 5-24
B. Iiyama
C. Kumayama
Two
Choices
Suppose that you decide to answer the question.
What is the expected value of the outcome?

Do you answer the question or do you walk away
with $64,000?
Chap 5-25
B. Iiyama
C. Kumayama
Two
Choices
Expected Value
125,000 1/2 + 32,000 1/2 = 78,500

Walk Away
64,000
Chap 5-26
Expected value of functions
of random variables
(discrete)
If P(x) is the probability distribution function of a
discrete random variable X , and g(X) is some
function of X , then the expected value of the
random variable g(X) is

x
E[g(X)] g(x)P(x) =

Chap 5-27
Example
A factory manager is considering whether to replace a
machine. A review of past reports indicates the
following probability distribution for the number of
breakdowns of this machine in a week.
Number of breakdowns 0 1 2 3 4
Probability 0.1 0.26 0.42 0.16 0.06

It is estimated that each breakdown costs the company
$1,500 in lost output. What is the expected weekly cost
to the company from breakdown of this machine?
Chap 5-28
Example
Let X be the number of weekly breakdowns
Let C be the cost of weekly breakdowns
C = ?
Chap 5-29
Example
Let X be the number of weekly breakdowns
Let C be the cost of weekly breakdowns
C(X) = 1500X
E(C(X)) = E(1500X) =
1500 ( ) x P x

1500 ( ) 1500
1500 1.82 $2730
X
x P x = =
= =

( ) ( )
0 0.10 1 0.26 2 0.42 3 0.16 4 0.06
1.82
X
E X x P x = =
= + + + +
=

Chap 5-30
Expected values of Linear Functions
of Random Variables
Let a and b be any constants.

a)

b)

c)

d)


E(a) a =
X
E(bX) b =
X
E(a bX) a b + = +
X Y
E[W] E[aX bY] a b = + = +
X Y
E[R] E[aX-bY] a -b = =
Chap 5-31
Variance and Standard Deviation
(discrete)
Variance of a discrete random variable X, denoted
X
2
, is
defined as the expectation of the squared deviation, (X -
X
)
2
,
of a random variable from its mean





Standard Deviation of a discrete random variable X






2 2
x
(x ) P(x)
X X
= =

2 2 2
x
E[(X ) ] (x ) P(x)
X
= =

Weighted
average of the
squares of
deviations from
the mean
Chap 5-32
Notes
For each integer n, the nth moment of X is EX
n
. The nth
central moment of X is E(X- )
n
. Aside from the mean
E(X) of a random variable, perhaps the most important
moment is the second central moment, more commonly
known as the variance.

The variance gives a measure of the degree of spread
of a distribution around its mean. Small values mean
that X is likely to be close to E(X). The standard
deviation is easier to interpret in that the measurement
unit on the standard deviation is the same as that for
the original variable X.

Chap 5-33
Notes
The concept of variance is used in comparing the
dispersions of probability distributions, but the
premise is that the two distributions have the same
expected value. Consider two investments having
the same expected returns, but the one with higher
variance is said to have greater risk. In finance,
standard deviation measures the variation of
returns around an assets mean, it is the most
common single indicator of the risk or variability of
a single asset.


Chap 5-34
Standard Deviation Example
(discrete)
Example: Toss 2 coins, X = # heads,
compute standard deviation (recall E(x) = 1)
2 2 2
(0 1) (.25) (1 1) (.50) (2 1) (.25) .50 .707
X
= + + = =
Possible number of heads
= 0, 1, or 2
2
x
(x ) P(x)
X
=

Chap 5-35
Variance of random variable g(X)
2
2
( ) ( )
If X is discrete
Var( ( )) [ ( ) ] [ ( ) ] ( )
g X g X
x
g X E g X g x P x = =

Chap 5-36
An alternative formula
for variance
2 2 2 2
Var(X) (X ) [ ( )] (X )-
X
E E X E = =
TA can show
the proof
Chap 5-37
Proof (let X be a discrete r.v.)
2
2 2
2 2
2 2
2 2
Var(X)= [( ) ]
[( 2 ( ) [ ( )] ]
= ( ) [2 ( )] [ ( ) ]
= ( ) 2 ( ) ( ) [ ( )]
= ( ) [ ( )]
E X EX
E X XE X E X
E X E XE X E E X
E X E X E X E X
E X E X

= +
+
+

2 2 2 2
2 2
2 2 2 2 2 2 2 2
( ) ( ) ( 2 ) ( )
= ( ) 2 ( ) ( )
Since ( ) by definition and ( ) 1 for
any discrete probability distribution
( ) 2 ( ) ( ) [ ( )]
x x
x x x
x x
x x
x P x x x P x
x P x xP x P x
xP x P x
x P x x P x E X E X
o

o
= = +
+
= =
= + = =




Chap 5-38
Variance of Linear Functions
of Random Variables
Let a and b be any constants.

a)

b)
c)
Var(a) 0 =
2 2
X
Var(bX) b =
2 2
X
Let Y= aX+b,
so Var (Y) = Var(aX b) a
and | |
Y X
a
+ =
=
TA can
show
proof
Chap 5-39
proof
2
2
2
2 2
2
Var( ) [( ) ( )]
Note that E(aX+b)=aE(X)+b
Var( ) [ ]
= [ ]
= [ ]
= Var( )
aX b E aX b E aX b
aX b E aX b aEX b
E aX aEX
a E X EX
a X
+ = + +
+ = +

Chap 5-40
An important special case of the previous results is the
standardized random variable




which has a mean 0 and variance 1
A Special Case

X
X

X
Z

=
Chap 5-41
standardized random variable
2
2 2
1
Let a= and b= in the linear function Z=a+bX.
Then
1
Z=a+bX=
so that
1
( ) ( ) 0
and
1 1 1
Var( ) Var( ) Var(X)= 1
X
X X
X X
X X X
X X X X
X X X X X
X X
X
X X X X X
X
X
X
E E X
X
X

o o

o o o

o o o o o

o
o o o o o

+ =

= = =

= = =
Chap 5-42
Joint Probability Function
The joint probability function of a pair of discrete
random variables X and Y expresses the
probability that X takes the specific value x and
Y takes the value y simultaneously:
P(X=x Y=y) = f(x,y)

Old idea: P(AB) applied to P(X=x Y=y)

New terminology: joint distribution
event
Random variable
Chap 5-43
Properties of Joint Probability Distribution of
Discrete Random Variables
The function f(x,y) is a joint probability distribution of the
discrete random variable X and Y, then
1.0< f(x,y) <1 for all (x,y)
2.
( , ) 1
x y
f x y =

e.g., If x=0,1,2; y = 0,1,2
( , ) ( , 0) ( ,1) ( , 2)
(0, 0) (0,1) (0, 2)
(1, 0) (1,1) (1, 2)
(2, 0) (2,1) (2, 2)
1
x y x
f x y f x f x f x
f f f
f f f
f f f
= + +
= + + +
+ + +
+ +
=

Chap 5-44
Example (Discrete r.v.)
Two refills for a ballpoint pen are selected at random
from a box containing 3 blue refills, 2 red refills, and 3
green refills.
X=# of blue refills selected
Y=# of red refills selected

Find the joint probability function f(x,y)
3 2 3
2
8
2
( , ) for x=0,1,2; y=0,1,2; 0 x+y 2
x y x y
C C C
f x y
C

= s s
Chap 5-45
Example (Discrete r.v.)
Joint Probability Distribution
x Row
f(x,y) 0 1 2 totals
0 3/28 9/28 3/28 15/28
y 1 3/14 3/14 3/7
2 1/28 1/28
Column totals
5/14

15/28

3/28

1
check: ( , ) (0, 0) (0,1) (0, 2) (1, 0) (1,1) (1, 2) (2, 0) (2,1) (2, 2)
1
x y
f x y f f f f f f f f f = + + + + + + + +
=

Chap 5-46
Marginal Distribution of X and Y
Suppose we are interested only in X, yet have to work
with the joint distribution of X and Y

Given the joint probability distribution f(x,y) of the
discrete random variables X and Y, the probability
distribution function g(x) of X alone is obtained by
summing f(x,y) over the values of Y.

The probability distribution function of h(y) of Y alone is
obtained by summing f(x,y) over the values of X.

We define g(x) and h(y) to be the marginal distribution
of X and Y.
Chap 5-47
The marginal distribution of X alone and of Y alone
are






( ) ( , )
( ) ( , )
y
x
g x f x y
h y f x y
=
=

Discrete
Chap 5-48
Example (Discrete r.v.)
x Row
f(x,y) 0 1 2 totals
0 3/28 9/28 3/28 15/28
y 1 3/14 3/14 3/7
2 1/28 1/28
Column totals
5/14

15/28

3/28

1
Show that the column and row totals above give the
marginal distribution of X alone and of Y alone
Chap 5-49
Example (Discrete r.v.)
Joint Probability Distribution
x Row
f(x,y) 0 1 2 totals
0 3/28 9/28 3/28 15/28
y 1 3/14 3/14 3/7
2 1/28 1/28
Column totals
5/14

15/28

3/28

1
g(2)
g(1)
g(0)
h(0)
h(1)
h(2)
Chap 5-50
A conditional probability is the probability of one
event, given that another event has occurred
(assume P(A) > 0):
P(A)
B) P(A
A) | P(B

=
The conditional
probability of B given
that A has occurred
Recall: Conditional Probability
Where A and B are now the events defined by X=x, Y=y, then
P(Y=y|X=x) = P(X=x, Y=y)/P(X=x) = f(x,y) / g(x) , where g(x)>0,
X and Y are discrete random variables
Chap 5-51
Conditional Probability Distribution
Let X and Y be two discrete random variables, the
conditional distribution of random variable Y, given that
X=x, is



Conditional distribution of random variable X, given that
Y=y, is

( , )
( | ) , ( ) 0
( )
f x y
f y x g x
g x
= >
( , )
( | ) , ( ) 0
( )
f x y
f x y h y
h y
= >
Chap 5-52
Example (Discrete r.v.)
Two refills for a ballpoint pen are selected at
random from a box containing 3 blue refills, 2
red refills, and 3 green refills.
X=# of blue refills selected
Y=# of red refills selected

Find the conditional distribution of X, given that
Y=1, and use it to determine P(X=0|1)
Chap 5-53
Example (Discrete r.v.)
x Row
f(x,y) 0 1 2 totals
0 3/28 9/28 3/28 15/28
y 1 3/14 3/14 3/7
2 1/28 1/28
Column totals
5/14

15/28

3/28

1
Chap 5-54
Definition of
Statistical Independence
Let X and Y be two discrete random variables
with joint probability distribution f(x,y) and
marginal distributions g(x) and h(y). The
random variable X and Y are said to be
statistically independent if and only if:
f(x,y) = g(x) h(y), for all (x,y) within their range.

If X and Y are independent, then following the
definition of conditional probability functions,
f(x|y) = f(x,y)/h(y) = g(x)h(y)/h(y)= g(x)

Chap 5-55
Example (Discrete r.v.)
Two refills for a ballpoint pen are selected at
random from a box containing 3 blue refills, 2
red refills, and 3 green refills.
X=# of blue refills selected
Y=# of red refills selected

Show that the random variable X and Y are
NOT statistically independent
Chap 5-56
Example (Discrete r.v.)
x Row
f(x,y) 0 1 2 totals
0 3/28 9/28 3/28 15/28
y 1 3/14 3/14 3/7
2 1/28 1/28
Column totals
5/14

15/28

3/28

1
Chap 5-57
Covariance (
X,Y
)

Let X and Y be random variables with joint probability
distribution f(x,y). The expected value of (X -
x
)(Y -
y
) is called
the covariance between X and Y




The covariance is a measure of the joint variability for two
random variables.

It is a measure of how well two variables are linearly related.


If X and Y are discrete
( , ) [( )( )] ( )( ) ( , )
x y x y
x y
Cov X Y E X Y x y f x y = =

Chap 5-58
An alternative formula for covariance



( , ) ( ) ( ) ( ) ( )
x y
Cov X Y E XY E X E Y E XY = =
Cov( , ) [( )( )]
= ( )
= ( ) ( ) ( )
= ( )
= ( )
X Y
X Y X Y
X Y X Y
X Y Y X X Y
X Y
X Y E X Y
E XY Y X
E XY E Y E X
E XY
E XY





=
+
+
+

Chap 5-59
note
The covariance between two random variables is a measurement
of the linear nature of the association between the two
The sign of Cov(X,Y) gives information regarding the direction of
the relationship between X and Y.
The covariance is positive when variables move together,
negative when they move in opposite directions. When the
covariance is zero, it indicates that there is no tendency for X and
Y to move together in a linearly related way.
But covariance can be any number and a given value of
Cov(X,Y), say 3, does not in itself give information about the
strength of the relationship between X and Y.



Cov(10X, 10Y) (10 10 ) (10 ) (10 )
100 ( ) 100 ( ) ( )
100[ ( ) ( ) ( )]
100 Cov(X,Y)
E X Y E X E Y
E XY E X E Y
E XY E X E Y
=
=
=
=
Chap 5-60
Correlation
The magnitude of
X,Y
does not indicate anything regarding the
strength of the relationship since it is not scale free

Introduce correlation
-1 s s1

= 0 no linear relationship between X and Y
> 0 positive linear relationship between X and Y
when X is high (low) then Y is likely to be high
(low)
= +1 perfect positive linear dependency
< 0 negative linear relationship between X and Y
when X is high (low) then Y is likely to be low
(high)
= -1 perfect negative linear dependency


Cov(X,Y)
Corr(X,Y)
Var(X)Var(Y)
XY
= =
Chap 5-61
Covariance and Independence
Suppose two random variables X and Y are statistically
independent, so f(x,y) = g(x)h(y). Then











But the converse is not necessarily true. X and Y may have zero
covariance and still be dependent in a non-linear way


So, 0
XY
=
( , ) ( )( ) ( ) ( )
= ( ) ( ) ( ) ( )
[ ( ) ( )][ ( ) ( )]
=[E(X)-E(X) 1]E(Y)-E(Y) 1]
=0
x y
x y
x y
x y
x y
x x y y
Cov X Y x y g x h y
x g x y h y
xg x g x yh y h y



=

=

Chap 5-62

Let X
1
, X
2
be 2 random variables with variances
1
2
and
2
2
. Then:
If X
1
and X
2
are independent random variables (i.e. the covariance
between X
1
and X
2
is 0), then the variance of their sum is the sum of
their variances


If the covariance between them is not 0, the variance of their sum is


If X
1
and X
2
are independent random variables, then the variance of
their difference is the sum of their variances


If the covariance between them is not 0, the variance of their
difference is




2 2
1 2 1 2
Var(X X ) = +
2 2
1 2 1 2
Var(X X ) + = +
2 2
1 2 1 2 1 2
Var(X X ) 2Cov(X , X ) + = + +

2 2
1 2 1 2 1 2
Var(X X ) 2Cov(X , X ) = +
Chap 5-63
What about:

Var(aX+bY)
Var(aX-bY)
2 2
Var(aX+bY)= Var( ) Var( ) 2 Cov( , ) a X b Y ab X Y + +
2 2
Var(aX-bY)= Var( ) Var( ) 2 Cov( , ) a X b Y ab X Y +
Chap 5-64
proof
2
2
2 2 2 2
2
The mean of aX+bY=E(aX+bY)=aEX+bEY
Var(aX+bY)= [( ) ( )]
= [( ( ) ( )]
= [( ( ) ( ) 2 ( )( )]
= [(
E aX bY aEX bEY
E a X EX b Y EY
E a X EX b Y EY ab X EX Y EY
a E X
+ +
+
+ +
2 2 2
2 2
) ] [( ) ] 2 ( )( )
= Var(X) Var(Y) 2 Cov(X,Y)
EX b E Y EY abE X EX Y EY
a b ab
+ +
+ +
2
2
2 2 2 2
2
The mean of aX-bY=E(aX-bY)=aEX-bEY
Var(aX-bY)= [( ) ( )]
= [( ( ) ( )]
= [( ( ) ( ) 2 ( )( )]
= [(
E aX bY aEX bEY
E a X EX b Y EY
E a X EX b Y EY ab X EX Y EY
a E X


+
2 2 2
2 2
) ] [( ) ] 2 ( )( )
= Var(X) Var(Y) 2 Cov(X,Y)
EX b E Y EY abE X EX Y EY
a b ab
+
+
Chap 5-65
The Binomial Distribution
Binomial
Hypergeometric
Poisson
Probability
Distributions
Discrete
Probability
Distributions
Chap 5-66
Bernoulli Distribution
Consider only two outcomes: success or failure
Let P denote the probability of success
Let 1 P be the probability of failure
Define random variable X:
x = 1 if success, x = 0 if failure
Then the Bernoulli probability function is

P P(1) and P) (1 P(0) = =
x P(x)
0 1-p
1 p
James Bernoulli
born in Switzerland,
1654-1705.
Chap 5-67
Bernoulli Distribution
Mean and Variance
The mean is = P




The variance is
2
= P(1 P)

P (1)P P) (0)(1 P(x) x E(X)
X
= + = = =

P) P(1 P P) (1 P) (1 P) (0
P(x) ) (x ] ) E[(X
2 2
X
2 2 2
= + =
= =

Chap 5-68
Generalization of the
Bernoulli distribution
A random experiment with two possible outcomes is
repeated n times and the repetitions are independent

Define a random variable X = # of successes in n trials

We are interested in P(X=x successes in n trials),
x=0,1,,n
Chap 5-69
The Binomial Distribution
Consider the following random variables:
A multiple choice test contains 10 questions, each with 4
choices, and you guess at each question. Let X= # of questions
answered correctly
In the next 20 births at a hospital, let X = the # of female births
Of all patients suffering a particular illness, 35% experience
improvement from a particular medication. In the next 50 patients
administered the medication, let X = # of patients who
experience improvement
Job offers were made to 10 job candidates who either accept of
reject the offer, let X = # of candidates who accept the offer

Chap 5-70
Binomial Probability Distribution
n trials will result in a sequence of n outcomes
one sequence with x successes and (n-x) failures is
S,S, , S F,F,,F


Recall P(success)=P, P(failure)=1-P
Since n trials are independent of one another, the
probability of observing this (and any) specific sequence
of outcomes is
[PPP] [(1-P) (1-P) (1-P)]=P
x
(1-P)
n-x

x times (n-x) times
x times
(n-x) times
Chap 5-71
P
x
(1-P)
n-x
only establishes the probability of occurrence of a
particular sequence involving x successes and (n-x) failures
But there are more than one way that x successes could be
arranged with (n-x) failures
Example: Suppose we have 3 independent trials and we are
interested in X=2
2 successes can be obtained from 3 independent trials in the
following ways (notice that order does not matter):
101 P
2
(1-P)
3-2

110 P
2
(1-P)
3-2

011 P
2
(1-P)
3-2
So P(X=2) = P
2
(1-P)
3-2
+ P
2
(1-P)
3-2
+ P
2
(1-P)
3-2
=3P
2
(1-P)
3-2





3
C
2

i.e. We can select any x locations from a
total n locations in which to place the
successes
Chap 5-72
# of Sequences with x Successes
in n Trials
The number of sequences with x successes in n
independent trials is:






These sequences are mutually exclusive, since no two
can occur at the same time
x)! (n x!
n!
C
n
x

=

Chap 5-73
P(x) = probability of x successes in n trials,
with probability of success p on each trial

x = number of successes in n independent trials,
(x = 0, 1, 2, ..., n)
n = sample size (number of trials or observations)
p = probability of success
P(X=x)
p (1- p)
x
n
x
=

Binomial Distribution b(x;n;p)
n
C
x
Chap 5-74
Binomial Distribution
Mean and Variance
X=# successes in n independent trials, each
with P(success) = P. Then X follows a binomial
distribution with

Mean
Variance
( ) E X nP = =
2 2
( ) (1 ) E X nP P o = =
Chap 5-75
Assumption of a binomial random variable
A fixed number of observations, n
e.g., 15 tosses of a coin; ten light bulbs taken from a warehouse
Two mutually exclusive and collectively exhaustive
outcomes
e.g., head or tail in each toss of a coin; defective or not defective
light bulb
Generally called success and failure
Probability of success is p , probability of failure is 1 p
Constant probability for each observation
e.g., Probability of getting a tail is the same each time we toss
the coin
Observations are independent
The probability of the outcome on one trial does not affect the
probability on other trials
Chap 5-76
Example
A politician believes that 25% of all
macroeconomists in senior positions will
strongly support a proposal he wishes to
advance. Suppose that this believe is correct
and that five senior macroeconomists are
approached at random.

What is the probability that at least one of the
five will strongly support the proposal?
Chap 5-77
X= # of macroeconomists support the proposal
This is a binomial distribution
P(X>1) = 1 P(X<1) = 1 P(X=0)
P(X=0) = ?
P(X=0) =
5
C
0
(0.25)
0
(0.75)
5

P(X=0) = 0.2373
P(X>1) = 1 0.2373 = 0.7627
Chap 5-78
The Hypergeometric
Distribution
Binomial
Poisson
Probability
Distributions
Discrete
Probability
Distributions
Hypergeometric
Chap 5-79
Consider the following two situations
Sampling with replacement
- A sample is drawn from the population (small sample, large population)
- Each item is drawn independently
- The probability of success is constant
(binomial assumptions are met)

Sampling without replacement
- A sample is drawn from the population (small population)
- Outcome of each draw is dependent
- The probability of success changes with each selection
(the hypergeometric probability model is used)

Notice: If N is large (N>10,000) and n is small (n<1%N), then the
change in probability after each draw is very small. In such situations
the binomial is a very good approximation and is typically used.
Chap 5-80
The Hypergeometric Distribution
The finite population of size N contains S successes
A random sample of n objects is taken without replacement
Outcomes of trials are dependent
Concerned with finding the probability of X successes in the
sample where there are S successes in the population
Chap 5-81
Hypergeometric Distribution Formula
Where
N = population size
S = number of successes in the population
N S = number of failures in the population
n = sample size
x = number of successes in the sample
n x = number of failures in the sample
S N S
x n x
N
n
C C
P(X=x)
C

=
Chap 5-82 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 4-82
Recall the example
New York State Lotto, 51 balls numbered 1 to 51, pick 6
distinct numbers (repetition is not possible). The state
randomly chooses the 6 distinct numbers + a bonus
ball. The exact match of the balls win the big jackpot.
Ordering does not matter. Whats the probability of
matching exactly (ignore the bonus ball) 4 balls?
6 45
4 2
51
6
(X=4)= 0.08%
So the random variable
X #exact matches in a sample of 6 balls
has a hypergeometric distribution.
C C
P
C
=
=
Chap 5-83 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 5-83
Example (Discrete r.v.)
A shipment of 8 similar chips contains 3 that are defective. If one
purchases 2 of these chips, find the probability distribution for the
number of defectives.
Let X=# of defectives purchased, so
x=0, 1, 2
And what about f(0), f(1), f(2)?
So the probability distribution of X is:

The probability distribution function can be written as:



x f(x)
0 10/28
1 15/28
2 3/28
3 5
2
8
2
( ) , 0,1, 2
x x
C C
f x x
C

= =
Chap 5-84

Example
3 different computers are checked from 10 in the
department. 4 of the 10 computers have illegal software
loaded. What is the probability that 2 of the 3 selected
computers have illegal software loaded?
Chap 5-85

Example
3 different computers are checked from 10 in the
department. 4 of the 10 computers have illegal software
loaded. What is the probability that 2 of the 3 selected
computers have illegal software loaded?

N = 10 n = 3
S = 4 x = 2
The probability that 2 of the 3 selected computers have illegal
software loaded is 0.30, or 30%.
0.3
120
(6)(6)
C
C C
C
C C
2) P(x
10
3
6
1
4
2
N
n
S N
x n
S
x
= = = = =

Chap 5-86
The Poisson Distribution
Binomial
Hypergeometric
Poisson
Probability
Distributions
Discrete
Probability
Distributions
Simon Denis Poisson,
Born in France, 1781-1840
Chap 5-87
The Poisson Distribution
Consider the following random variables:
The # of failures in a large computer system during a
given day
The # of customer complaints received by a
department store in a given month
The # of students arrive at the canteen during each
30 minutes time interval from 4pm to 6pm on
weekdays
The # of dents, scratches, or other defects in a large
roll of sheet metal used to manufacture filters
Chap 5-88
The Poisson Distribution
You wish to count the number of times an event occurs in a given
continuous interval (usually time intervals.)
It is possible to divide the time interval of interest into many short
subintervals (like an hour into seconds), and the probability of the
occurrence of an event in any subinterval is very small
Assumptions of a Poisson Random Variable:
The probability of the occurrence of an event is constant for all
subintervals (random occurrence)
The probability of more than one outcome in the same short
interval is negligible
The number of outcomes in a specific time period is independent
of the outcome in another disjoint time period (independence)


Chap 5-89
Poisson Distribution P(x; )
where:
X = # of successes over a given time or area
x = realized values of the r.v. X
= expected number of successes per given time or area; >0
e = base of the natural logarithms (2.71828...)

x
e
P(X=x)
x!

=
Chap 5-90
We can derive the equation for computing
Poisson probabilities from the binomial
probability distribution by taking the
mathematical limits as P 0 and n infinity.
Chap 5-91
Poisson Approximation to
the Binomial Distribution
Let X be the # of successes resulting from n independent trials,
each with probability of success p. So X is a binomial random
variable with probability distribution b(x;p;n). If we let n goes to
infinity, let p goes to zero, such that its mean np remains constant,
(in general need np s 7), then this distribution can be approximated
by the Poisson distribution with = np.

The probability function of the approximating distribution is



The Poisson distribution is the continuous limit of the discrete
binomial distribution
( )
( ) for x=0,1,2,...
!
np x
e np
P x
x

=
Chap 5-92
Proof
!
(1 ) (1 )
!( )!
( 1)( 2) ( ( 1)) ( 1)( 2) ( 1)
(1 ) (1 )
! !
Let , is fixed, let n
n x n x x n x
x
x n x x n x
n
C p p p p
x n x
n n n n x n n n n x
p p p p
x x
p
n

+
= =
=
0
(1 )
!
lim
x
n x n x
x
n
p
np
e
C p p
x

=
=
Chap 5-93
Proof
Let , is fixed, let n
( 1)( 2) ( 1)
( ) (1 )
!
( 1)( 2) ( 1) 1
( ) (1 ) (1 )
!
( 1)( 2) ( 1) 1
[ ] (1 ) (1 ) ( )
!
1 2
[ ( )( ) (
lim
lim
lim
lim
x n x
n
x n x
x
n
x n x
x
n
n
p
n
n n n n x
x n n
n n n n x
x n n n
n n n n x
n n n x
n n n n x
n n n

=
+

+
=
+


=
=
1 1
)] (1 ) (1 ) ( )
!
1 2 1 1
[1(1 )(1 ) (1 )] (1 ) (1 ) ( )
!
lim
x n x
x n x
n
n n n x
x
n n n n n x

=
Chap 5-94
Proof
1 2 1
But [1(1 )(1 ) (1 )] 1
1
(1 ) (1 ) ( )
!
(1 ) (1 )
1
But (1 ) {(1 ) }
1
note that (1 )
1
(1 ) {(1 ) }
And
lim
lim
lim
!
lim lim
lim

lim lim
n
x n x
n
n x
n
n
y
n
n
x
n n n
n n x
x
n n
n
n
n
n n
e
y y
e
n
n
n n
x

= +


+ =

= + =


=
=

(1 ) 1 1 0 as
lim
x x
n
n
n n

= =
Chap 5-95
Proof
0
(1 ) 1
lim
! !
x x
n x n x
x
n
p
np
e
C p p e
x x

=
= =
Chap 5-96

Chap 5-97
Poisson Approximation to
the Binomial Distribution
Examples:
- An insurance company will hold a large number of life policies on
individuals of any particular age, and the probability that a single
policy will result in a claim during the year is very low. Here, we
have a binomial distribution with large n and small p

- A company may have a large number of machines working on a
process simultaneously. If the probability that any one of them will
break down in a single day is small, the distribution of the number
of daily breakdowns is binomial with large n and small p
Chap 5-98
Choice of the binomial or
the Poisson for a particular application
Review the assumptions for the two probability distribution
Binomial (rule of thumb): small sample (not possible to find a
limiting probability with n becoming very large); p(success) is
between 0.05 and 0.95
Poisson (rule of thumb): n could be potentially very large, the mean
(np) number of successes over that large set of cases is relatively
small (in general need np s 7). For example, if p<0.05 and n is
large, can approximate the binomial probability distribution with the
Poisson distribution


Chap 5-99
Poisson Distribution
mean and variance
Mean

Variance and Standard Deviation
E(x) = =
]
2
= =
2
) [( X E
=
where = expected number of successes per time or space unit

Chap 5-100
Proof Mean of a Poisson Dist.
0
0
1
0
1
1 0
0 0
( ) ( )
( )
!
( )
( 1)!
( ) but recall ( ) 1
( 1)!
so ( ) ( ; ) 1
!
x
x
x
x
x
x
x x
y
y y
E X xP x
e
x
x
e
x
x x
e
f x
x
e
p y
y

=


= =

= =
=
=
=

= =

= = =

Chap 5-101
Variance of a Poisson Dist.
2 2 2
2 2
2
2 2
0
2 2
0
2
2
Var(X) ( ) ( ) [ ( )]
( ) ( ) ( ) [ ( )]
( ( 1)) ( ) [ ( )]
we know ( ) and [ ( )]
what is ( ( 1)) ?
( ( 1)) ( 1)( )
!
( 1)( )
!
( 1)(
( 1)
x
x
x
x
x
E X E X E X
E X E X E X E X
E X X E X E X
E X E X
E X X
e
E X X x x
x
e
x x
x
e
x x
x x

=

=

= =
= +
= +
= =

=
=
=

0
2
2
2 0
2
2
2 2
)
( 2)!
( ) recall ( ) 1
( 2)!
1
Var(X) =
x
x
x x
x
e
f x
x

=

= =

= =

=
=
+ =

Chap 5-102
Example
A computer center manager reports that his computer
system experienced three component failures during
the past 100 days. What is the probability of no failure in
a given day?

Poisson distribution assumptions
Large number of components, n could be large
Each component has the same small probability of
failure
First failure does not affect the probability of second
failure
More than one occurrences in one subinterval is
negligible

Chap 5-103
Example
Let X=number of failures in a given day be a Poisson
random variable
From past experience, the expected number of failure
per day is 3/100, or =0.03





0.03 0
0.03
( 0) 0.97
0!
e
P X

= = =
Chap 5-104
Example
An analyst predicted that 3.5% of all small
corporation would file for bankruptcy in the
coming year. For a random sample of 100 small
corporations, estimate the probability that at
least 3 will file for bankruptcy in the next year,
assuming that the analysts prediction is correct.
Chap 5-105
Let X = number of filings for bankruptcy
This is a binomial random variable with n=100 and p=0.035
So = np =3.5
Can we approximate this distribution with a Poisson distribution with =
3.5?
Poisson (rule of thumb): n could be potentially very large, the mean (np)
number of successes over that large set of cases is relatively small (in
general need np s 7). For example, if p<0.05 and n is large, can
approximate the binomial probability distribution with the Poisson
distribution


3.5 0 3.5 1 3.5 2
( 3) 1 ( 2) 1 { ( 0) ( 1) ( 2)}
(3.5) (3.5) (3.5)
1 {( ) ( ) ( )} 0.679
0! 1! 2!
P X P X P X P X P X
e e e

> = s = = + = + =
= + + =
Chap 5-106
Example: Portfolio Analysis
STOCK A
PRICE
STOCK B PRICE
$40 $50 $60 $70
$45 0.24 0.003333 0.003333 0.003333
$50 0.003333 0.24 0.003333 0.003333
$55 0.003333 0.003333 0.24 0.003333
$60 0.003333 0.003333 0.003333 0.24
Entry in each cell gives the join probability distribution
of stock A and Bs prices.
Let random variable X be the price for stock A
Let random variable Y be the price for stock B
Chap 5-107
Whats the probability distribution of stock Xs prices?
x
45 0.249999 0.25
50 0.249999 0.25
55 0.249999 0.25
60 0.249999 0.25
( 55) (55, )
Y
P X P y = =

( 60) (60, )
Y
P X P y = =

( 50) (50, )
Y
P X P y = =

( 45) (45, )
Y
P X P y = =

( ) P X x =
( ) P X x = ( ) P X x =
2 2
2 2 2 2 2
2 2 2
( ) 45 0.25 50 0.25 55 0.25 60 0.25 $52.5
Var( ) ( ) [ ( )]
( ) 45 0.25 50 0.25 55 0.25 60 0.25 2787.5
Var( ) ( ) [ ( )] 2787.5 52.5 31.25
E X
X E X E X
E X
X E X E X
= + + + =
=
= + + + =
= = =
Chap 5-108
Whats the probability distribution of stock Ys prices?
y
40 0.249999 0.25
50 0.249999 0.25
60 0.249999 0.25
70 0.249999 0.25
( 60) ( , 60)
X
P Y P x = =

( 70) ( , 70)
X
P Y P x = =

( 50) ( , 50)
X
P Y P x = =

( 40) ( , 40)
X
P Y P x = =

( ) P Y y =
( ) P Y y = ( ) P Y y =
2 2
2 2 2 2 2
2 2 2
( ) 40 0.25 50 0.25 60 0.25 70 0.25 $55
Var( ) ( ) [ ( )]
( ) 40 0.25 50 0.25 60 0.25 70 0.25 3150
Var( ) ( ) [ ( )] 3150 55 125
E Y
Y E Y E Y
E Y
Y E Y E Y
= + + + =
=
= + + + =
= = =
Chap 5-109
( , ) ( ) ( ) ( )
( ) ( , ) 45[(40)(0.24) (50)(0.003333) (60)(0.003333) (70)(0.003333)]
+ 50[(40)(0.003333) (50)(0.24) (60)(0.003333) (70)(0.003
x y
Cov X Y E XY E X E Y
E XY xyP x y
=
= = + + +
+ + +

333)]
+ 55[(40)(0.003333) (50)(0.003333) (60)(0.24) (70)(0.003333)]
+ 60[(40)(0.003333) (50)(0.003333) (60)(0.003333
+ + +
+ + ) (70)(0.24)]
= 2927.3235
( , ) ( ) ( ) ( ) 2946.6552 52.5 55 59.1552
( , ) 59.1552
0.9465
Var(X)Var(Y) 31.25 125
XY
Cov X Y E XY E X E Y
Cov X Y

+
= = =
= = =

Chap 5-110

The market value, W, for the portfolio is given by the
linear function




W 5X 10Y = +
Chap 5-111

The mean value for W is



The variance and standard deviation for W is



(continued)
W
E[W] E[5X 10Y]
5 52.5 10 55=812.5
= = +
= +
2 2 2 2 2
W X Y
2 2
W
5 10 2 5 10Cov(X,Y)
=5 31.25 10 125 2 5 10 59.16=19197.25
138.55
= + +
+ +
=
Chap 5-112
Example: Portfolio Analysis (continued)
STOCK C
PRICE
STOCK D PRICE
$40 $50 $60 $70
$45 0.003333 0.003333 0.003333 0.24
$50 0.003333 0.003333 0.24 0.003333
$55 0.003333 0.24 0.003333 0.003333
$60 0.24 0.003333 0.003333 0.003333
Entry in each cell gives the join probability distribution of stock C and
Ds prices.
Chap 5-113
Compare to the previous stock pair X,Y
( ) ( )
( ) ( )
Var( ) Var( )
Var( ) Var( )
( , ) 59.16 ( , ) 59.16
E C E X
E D E Y
C X
D Y
Cov C D Cov X Y
=
=
=
=
= = =
2 2 2 2 2
W C D
2 2
W
5 10 2 5 10Cov(C,D)
=5 31.25 10 125 2 5 10 ( 59.16=7365.25
85.8
= + +
+ +
=
We see that the effect of the negative covariance is to
reduce the variance and hence to reduce the risk of the
portfolio
Chap 5-114
Example
A company receives large shipments of parts from two sources.
70% come from a supplier whose shipments typically contain 10%
defectives, while the remainder are from a supplier whose
shipments typically contain 20% defectives.
Given: P( shipment is from supplier A)=0.7
P( shipment is from supplier B)=0.3
P( defectives | supplier A) = 0.1
P( defectives | supplier B) = 0.2
Question: A manager receives a shipment but does not know the
source. A random sample of 20 items from this shipment is tested,
and 1 of the parts is found to be defective. What is the probability
that this shipment came from supplier A?
i.e. find P( shipment is from supplier A | 1 item from a sample of 20
items is defective). This is asking you to update the original P(
shipment is from supplier A)=0.7

Chap 5-115
(shipment is from A| 1 part from a sample of 20 is defective)
= ( | 1)
( 1)

( 1)
( 1| )
( )
( 1)
We know P(A) = 0.7, we don't know ( 1| ) and ( 1)
How to find ( 1| ) ?
If the shipment is
P
P A x
P A x
P x
P x A
P A
P x
P x A P x
P x A
=
=
=
=
=
=
=
= =
=
from supplier A, we know that P(defective from supplier A)=0.1,
if defective is our "success" here, we already have the probability of "success" given.
Let X be a binmoial random variable denoting the n
20 1 19
1
20 1 19 20
1 1
umber of defectives from supplier A.
( 1| ) (0.1) (0.9)
How to find ( 1) ?
( 1) ( 1 ) ( 1 ) note that A and B are m.e. and A B=S
= ( 1| ) ( ) ( 1| ) ( )
(0.1) (0.9) 0.7 (0.
P x A C
P x
P x P x A P x B
P x A P A P x B P B
C C
= =
=
= = = + =
= + =
= +
1 19
20 1 19
1
20 1 19 20 1 19
1 1
2) (0.8) 0.3
where ( 1| ) is found in a similar way as ( 1| )
(0.1) (0.9) ( 1| )
so we have ( | 1) ( ) 0.7
( 1) (0.1) (0.9) 0.7 (0.2) (0.8) 0.3

P x B P x A
C P x A
P A x P A
P x C C

= =
=
= = =
= +
= 0.916
See how P(A) =0.7 has been updated to ( | 1) 0.916 in this case? P A x = =