BUS 5 Quantitative Techniques in Business 5

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PROBABILITY CONCEPTS AND APPLICATIONS
Objectives
Students will be able to:
Understand the basic foundations of probability analysis
Understand the difference between mutually exclusive and collectively exhaustive events
Describe statistically dependent and independent events
Describe and provide examples of both discrete and continuous random variables
Explain the difference between discrete and continuous probability distributions

Probability
a chance that something will happen
- a numerical statement about the likelihood that an event will occur
- expressed as fraction (, , ) or as decimals (0.25, 0.5, 0.75) between 0 and 1
Experiment
doing something
an activity that produces an event
Event(s)
one or more of the possible outcomes of doing something
any result of an experiment that cannot be divided into smaller components

Basic Statements about Probability

1. The probability, P, of any event or state of nature occurring is greater than or equal to 0 and less than
or equal to 1.
That is: 0 < P(event) <1
2. The sum of the simple probabilities for all possible outcomes of an activity must equal 1.

Frequencies of Demand

Types of Probability
1. Objective Probability

() =

1
() =
2 ( )

13
() =
52
1
= = 0.25 = 25%
4

2. Subjective Probability
When logic and past history are not appropriate, probability values can be assessed
subjectively.
The accuracy of subjective probabilities depends on the experience and judgment of
the person making the estimates.
Opinion polls can be used to help in determining subjective probabilities for
possible election returns and potential political candidates.

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Delphi method, a panel of experts is assembled to make their predictions of the
future.

Types of Events
Mutually exclusive events Not mutually exclusive events

one and only one event can take place two or more events occur at one time
at a time Addition rule:
Addition rule: P(A or B) = P(A U B)
P(A or B) = P(A U B) = P(A) + P(B) P(A & B)
= P(A) + P(B) = P(A) + P(B) P(A B)

Collectively Exhaustive Events

Events are said to be collectively exhaustive if the list of outcomes includes every possible
outcome:
i.e. heads and tails as possible outcomes of coin flip

Mutually Exclusive
P(event A or event B) = P(event A) + P(event B)
or:
P(A or B) = P(A) + P(B)
i.e.,
P(spade or club) = P(spade) + P(club)
= 13/52 + 13/52
= 26/52
= 1/2 or 50%

Not Mutually Exclusive

P(event A or event B) =
P(event A) + P(event B) - P(event A and event B both occurring)
or
P(A or B) = P(A)+P(B) - P(A and B)

Three Major Classifications of Probability According to the Source of Information:

1. Subjective probability
based on personal belief or feelings
best estimate of someone who is informed about the conditions that influence the experiment
2. Classical probability
a priori probability
the probability value is determined without doing the experiment
every possible outcome of an experiment is assumed to be equally likely, thus the probability of an
outcome is:
P(A) = 1/ total number of possible outcomes
3. Relative frequency of occurrence

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probability of a particular outcome of an experiment equals the proportion of the past
experiments in which this outcome occurred
defines probability as either:
a) the proportion of times that an event occurs in the long run when conditions are stable, or
b) the observed relative frequency of an event in a very large number of trials.

Probabilities under conditions of:

Statistical Independence Statistical Dependence

probability of occurrence of one event probability of occurrence of some event is

has no effect on the probability of the dependent upon or affected by the
occurrence of any other event occurrence of some other event

Under Statistical Independence

1. Marginal Probability
simple probability of the occurrence of an event (unconditional)
Probability of A = P(A)
2. Joint Probability
the product of marginal probabilities of 2 or more independent events occurring or
in succession.
P(AB) = P(A) * P(B)*P(n)
Where
P(AB) = joint probability of events A and B occurring together, or one after the other
P(A) = marginal probability of event A
P(B) = marginal probability of event B
Example:
P(6 on first and 2 on second roll) = P (tossing a 6) x P(tossing a 2)
= 1/6 x 1/6 = 1/36 or 0.028
3. Conditional Probability
probability that a second event will occur (B) if a first event (A) has already happened
the same as unconditional probability
P(BIA) = P(B)

Under Statistical Dependence

Marginal Probability
exactly the same as that of statistically independent event Probability of A = P(A)
Joint Probability
P(AB) = P(A| B) * P(B)
Conditional Probability
probability that a second event will occur if a first event has already happened
the probability of event B given that event A has occurred P(B|A) = P(AB)/P(A)
the probability of event A given that event B has occurred P(A|B) = P(AB)/P(B)

Conditions of Statistical Independence Conditions of Statistical Dependence

Marginal Probability Marginal Probability

Probability of A = P(A) Probability of A = P(A)

Joint Probability Joint Probability

P(AB) = P(A) * P(B)*P(n) P(AB) = P(AIB) * P(B)

Conditional Probability Conditional Probability

P(BIA) = P(B) P(AIB) = P(AB)/P(B)

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Example (Statistically Independent)
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A bucket contains 3 black balls, and 7 green balls. We draw a ball from the bucket, replace it, and
draw a second ball
1. P(black ball drawn on first draw)
P(B) = 0.30 (marginal probability)
2. P(two green balls drawn)
P(GG) = P(G)*P(G)
= 0.70*0.70 = 0.49 (joint probability for two independent events)
3. P(black ball drawn on second draw, first draw was green)
P(B|G) = P(B) = 0.30 (conditional probability)
4. P(green ball drawn on second draw, first draw was green)
P(G|G) = 0.70 (conditional probability)

Example (Statistically Dependent)

Assume that we have an urn containing 10 balls of the following descriptions:
4 are white (W) and lettered (L)
2 are white (W) and numbered N
3 are yellow (Y) and lettered (L)
1 is yellow (Y) and numbered (N)

Then:
P(WL) = ? 4/10 = 0.40
P(WN) = ? 2/10 = 0.20
P(W) = ? 6/10 = 0.60
P(YL) = ? 3/10 = 0.3
P(YN) = ? 1/10 = 0.1
P(Y) = ? 4/10 = 0.4

Example:
Your stockbroker informs you that if the stock market reaches the 10,500 point level by January,
there is a 70% probability the Tubeless Electronics will go up in value. Your own feeling is that there is
only a 40% chance of the market reaching 10,500 by January.
What is the probability that both the stock market will reach 10,500 points, and the price of
Tubeless will go up in value?

Solution:
Let M represent the event of the stock market reaching the 10,500 point level, and T represent
the event that Tubeless goes up.
Then:
a.) Statistically Dependent
b.) Joint
c.) P(AB) = P(A| B) * P(B)
P(MT) =P(T|M)P(M)
= (0.70)(0.40)
= 0.28

Seatwork:
Use the blank space in the next page to answer.

A shoe manufacturer places an order for the leather required to produce a specified number
of pairs of shoes for a fixed shipment date. The probability that the leather will be received promptly
and that the shoes will be manufactured by a fixed shipment date is 0.60. There is a 75% probability
that the leather will be received promptly.
What is the Probability that the shipment date will be met on time given that the leather is
received on time?

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Random Variable
a variable that takes on different values as a result of the outcomes of a random experiment
a value or magnitude that changes from occurrence to occurrence in no predictable
sequence
the values of a random variable are the numerical values corresponding to each possible
outcome of the random experiment

Types of Random Variable

1. Discrete
if a random variable is allowed to take on only a limited number of values. i.e., the number of
automobiles sold in a year
Expected value
weighted average of the outcomes expected in the future
E = x * P(x)
2. Continuous
if a random variable is allowed to take on any value within a given range . i.e., temperature,
product lifetime

Probability Distribution
Listing of the probabilities associated with all the possible outcomes that could result if the
experiment were done
Basis
Theoretical consideration
Subjective assessments
Experience
Forms
Graphical
Tabular

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Graphical
Probability
0.6 of a tail in 2 tosses of
a fair coin
0.5

0.4

Probability of 0.3
this
outcome, 0.2
P(T)
0.1

0
0 1 2

Tabular

Types of Probability Distributions

Discrete Continuous
1. Binomial distribution 1. Exponential distribution
2. Poisson distribution 2. Normal distribution

The expected value of a discrete distribution is a weighted average of the values of the random
variable.
n
E ( X ) X i P(X i )
i 1
Where
X i = random variables possible values
P( X i ) = probability of each random variables possible values
n

i 1
= summation of each of the random variables possible values

E( X ) = expected value or mean of the random variable

The variance of a probability distribution is a number that reveals the overall spread or
dispersion of the distribution.
n 2

2 X i E X P X i
i 1

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A related measure of dispersion or spread is the standard deviation

= = 2
Where
= square root
= standard deviation
=
= 1.29 = 1.14

Binomial Probability Distribution

Describes discrete data resulting from an experiment called a Bernoulli process
Bernoulli Process
1. Each trial has only 2 possible outcomes
2. The (characteristic or inherent) probability remains fixed (constant) over time
3. The trials are statistically independent

Assumptions:
1. Trials follow Bernoulli process two possible outcomes
2. Probabilities stay the same from one trial to the next
3. Trials are statistically independent

Generalizations of the graphical appearance of the Binomial Probability Distributions:

1. When p is small (.1) the binomial is skewed to the right.
2. As p increases (to .4), the skewness is less noticeable.
3. When p = .5, the binomial distribution is symmetrical
4. When p is larger than .5, the distribution is skewed to the left.
5. The probabilities for any pair of complementary p and q values (i.e., 0.1 and 0.9; 0.2 and 0.8;
0.3 and 0.7; 0.4. and 0.6) are the same except that they are reversed. (Fig. 2-17, p. 60)

The binomial distribution is used to find the probability of a specific number of successes
out of n trials of a Bernoulli process.
n!
Probability of r successes in n trials p r q nr
r!n - r !
=
=
We let
=
= 1 =

Example 1:
Some field representatives of the Environmental Protection Agency are doing spot checks of
water pollution in streams. Historically, 8 out of 10 such tests produce favorable results, that is, no
pollution. The field group is going to perform 6 tests and wants to know the chances of getting exactly
3 favorable results from this group of tests.

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n!
Probability of r successes in n trials p r q nr
r!n - r !
p 0.8
q 0.2
r 3
n6

n!
Probabilit y of 3 favorable tests out of 6 p r q nr
r!n - r !
6!
Probabilit y of 3 favorable tests out of 6 0.8 3 0.2 6 3
3!6 - 3!
6!
Probabilit y of 3 favorable tests out of 6 0.8 3 0.2 3
3!3!
65 43 2 1
Probabilit y of 3 favorable tests out of 6 (0.512)( 0.008)
(3 2 1)3 2 1
120 0.492
Probabilit y of 3 favorable tests out of 6 (0.0041) 0.082
6 6

There is less than 1 chance in 10 of getting 3 favorable tests out of 6.

Example 2:
Five employees are required to operate a chemical process; the process cannot be started
until all 5 work stations are manned. Employee records indicate there is a 0.4 chance of any one
employee being late, and we know that they all come to work independently of each other.
Management is interested in knowing the probabilities of 0,1,2,3,4, or 5 employees being late, so that a
decision concerning the number of back-up personnel can be made.

n!
Probability of r late arrivals out of n employees p r q n r
r! n - r !
p 0.4
q 0.6
n 5

for r 0 :
5!
P(0) 0.4 0 0.6 5 0
0!5 - 0 !
5 4 3 2 1
P(0) )( 0.7776)
(1
)5
(1 4 3 2 1
P(0) 0.7776

for r 1 :
5! 5!
P(1) 0.410.6 51 (0.4)( 0.6 4 )
1!5 - 1! 1!4 !
3
5 4 2 1
P(1) (0.4)( 0.1296)
(1)4
3 2
1
P(1) 0.2592

r 2 : P(2) 0.3456
r 3 : P(3) 0.2304
r 4 : P(4) 0.0768
r 5 : P(5) 0.1024

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Poisson distribution
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A discrete distribution in which the probability of the occurrence of an event within a small time
period is very small, in which the probability that two or more such event will occur within the
same time interval is effectively 0, and in which the probability of the occurrence of the event
within one time period is independent of where that period is.
Is useful in analyzing certain processes that can be described by a discrete variable.
Poisson random variable is usually represented by letter X, which can take on integer values
(0,1,2,3,4,5, and so on); when one of the specific values that X can take is referred, a lowercase x
is used.
The probability of exactly x occurrences in a Poisson distribution is calculated using the formula:

Lambda (the average number of occurrences

per interval of time) raised to the x power e (2.71828, the base of the natural logarithm
system) raised to the negative lambda power

x e
P( x)
x!

X factorial
Probability of exactly x
occurrences

Example 1:
Consider an emergency room of a small rural hospital where the past records indicate an
average of 5 arrivals daily. The demand for emergency room service at this hospital is distributed
according to a Poisson distribution. The hospital administrator wants to calculate the probability that
exactly 0, 1, 2, 3, 4 and 5 arrivals per day.
x e
P( x)
x!

x 0; 5
50 e 5 10.00674
P ( 0) 0.00674
0! 1
x 1; 5
51 e 5
P (1) 0.03370
1!
x 2; 5 P (0) 0.00674
5 2 e 5 P (1) 0.03370
P ( 2) 0.08425
2! P ( 2) 0.08425
x 3; 5
P (3) 0.14042
53 e 5
P (3) 0.14042 P ( 4) 0.17552
3!
P (5) 0.17552
x 4; 5
0.61615
5 4 e 5
P ( 4) 0.17552
4!
x 5; 5 The sum of the 6 probabilit ies 0.61615,
5
5 e 5 which is less than 1 because it is possible to
P (5) 0.17552
5! have more than 5 arrivals on any given day

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Example 2:
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Suppose the hospital administrator wants to know the probability of more than 3 calls for
emergency room service on a given day. Compute P(more than 3).

P (0) 0.00674
P (1) 0.03370
P ( 2) 0.08425
P (3) 0.14042
0.26511

P ( more than 3) 1 - 0.26511 0.73489

the administra tor have to be prepared to have more than 3 calls per day slightly less than
three three quarters of the time

Exponential Distribution
A continuous probability distribution used to describe the distribution of service times in
a service facility
With the exponential distribution, and all other continuous distributions, there are
infinite number of possible values for the random variable
The Probability Density Function for exponential distribution is given by

p(t ) e t
where
t the service time
the mean service rate (units serviced per unit time)
e 2.71828, the base of the natural logarithm system
PROBABILITY DENSITY FUNCTION for continuous random variables, the
probability that the random variable falls within any given interval is the area
under the density function in the interval in question
The equation for exponential distribution is given by

P(T t ) 1 e t

In Exponential probability distribution, we will

be interested in finding P(T<t), the service
probability that the service time T will be less
than or equal to some specific value t.

Example 1:
Suppose the exponential probability distribution represents the time it takes for a
microcomputer repair facility to repair 1 unit, and suppose the mean repair time has been found to
be 3 hours. Thus , the mean service rate, is 1/3 unit per hour. What is the probability that service on a
faulty microcomputer will be completed in 2 or fewer hours?
Solution: P (T t ) 1 e t
P (T 2) 1 e (1/ 3)( 2 )
P (T t ) 1 e 2 / 3
P (T t ) 1 0.5134
P (T t ) 0.4866

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Normal Distribution
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A distribution of a continuous random variable in which the curve has a single peak, in which it
is bell-shaped, in which the mean lies at the center of the distribution and the curve is
symmetrical around a vertical line erected at the mean, and in which the two tails extend
indefinitely and never touches the horizontal axis

The Mean of a Distribution

The average or mean is known as a measure
of central tendency
Sample mean is computed as
xi
x
n
Population mean is computed as
xi

N
The Standard Deviation of a Distribution
Measure of the tendency for data to disperse
or spread out around its own mean
Sample mean is computed as

xi2
Formula for Z 2
N

=

Where
=
=
=
= ,

Example:
Haynes Construction Company builds primarily three- and four-unit apartment buildings (called
triplexes and quadraplexes) for investors, and it is believed that the total construction time in days
follows a normal distribution. The mean time to construct a triplex is 100 days, and the standard
deviation is 20 days. Recently, the president of Haynes Construction signed a contract to complete a
triplex in 125 days. Failure to complete the triplex in 125 days would result in severe penalty fees. What is
the probability that Haynes Construction will not be in violation of their construction contract?

=

125 100
=
20
25
= = 1.25 ~ 0.89435 or 89%
20

If the firm finishes this triplex in 75 days or less, it will be

awarded a bonus payment of $5,000. What is the probability that Haynes will receive the bonus?

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( > 125) = 1.0 ( 125)
= 1.0 0.89435 = 0.10565

What is the probability that the triplex will take between 110
and 125 days?

(110 < < 125) = ( 125) ( < 110)

110 100
= = = 0.5
20
(110 < < 125) = 0.89435 0.69146 = 0.20289

Example 2
Consider an accounts receivable auditor examining customer accounts for a client. Past
records indicate that the mean amount per account is $5,000 and that this particular random variable
has a standard deviation of $1,000.

a. What is the probability that an account selected at random will have a balance of more than
$5,000?

0.5 of area

b. What is the probability that an account selected at random will have a balance between
$5,000 and $6,500?
$5,000

If we look up z=1.5 in the normal distribution table, we find a probability of 0.93319.

Since the area between the left-hand tail of then normal curve and the mean is 0.5 of the
area, we obtain the answer by subtracting 0.5 from 0.93319 to get 0.43319
Therefore, the chances of randomly getting an account with between $5,000 and $6,500 as a
balance are slightly higher than 0.4.

c. What is the probability that an account drawn will have a balance of more than $7,000?

If we look in z table for a z value of 2, we find a

probability of 0.97725, which represents the
probability that an account will have a balance
of less than $7000.
Since the entire area under the normal curve has
a value of 1.0, we subtract 0.97725 from 1.0 to
get the answer of 0.02275.

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Seatwork:
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The Upstate Chemia Company has developed a low-cost spin-stabilized third stage rocket for
injecting satellites into orbit. This rocket is being considered for use in conjunction with the IMP
spacecraft for a mission in which a lunar orbit is desired. Upstate has run 10 tests on the rocket and has
determined that with a payload of 150 pounds and the weight of the IMP, the velocity increase
provided by this rocket would be as follows:
a. Assuming the velocity added by this rocket is normally
distributed, determine the mean and the standard deviation of the
inhjection velocity for the IMP mission.
b. Assume that the ptoject manager for the IMP mission has
completed his aalysis for the systems of the spacecraft, the velocity
added by the Upstate Cemicals third stage rocket must be
between 6, 790 and 6, 850 feet per second. What is the probability
that the Mission will fail because of the incorrect transfer orbit to the
moon?

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