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PROBABILITY
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Introduction to Probability
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3. INTRODUCTION TO PROBABILITY
OBJECTIVES
On completion of this unit students should be able to:
1. Calculate and interpret simple probabilities using counting and tree diagrams
2. Calculate probabilities of mutually exclusive events, independent events and complementary
events
3. From a crosstabulation calculate conditional probabilities
4. Use the probability distribution of a discrete random variable to calculate probabilities and
to calculate and interpret the expected value and standard deviation of the random variable.
3.1
Prelude
Roger Federer is to play Andy Roddick. Who will win? If you select Federer it is unlikely that you will
be totally certain of his victory but rather you would say that he would probably win, or that he had a
better (or higher) chance than Roddick of winning.
The topic of probability aims to quantify this sense of probably or more likely or higher chance. If we
say that 100% probability means that a player is certain to win and 0% means that they are certain to
lose then 50% would mean that both players have the same chance. If you select Federer to win, what
percentage probability would you allocate?
60%
80%
95%
There are many other situations where the outcome is uncertain but where a probability can be assigned.
Many of these are subjective so that different people will give different estimates of the probability.
Examples include sporting contests, whether it will rain tomorrow and share prices rising or falling.
In other situations the probability can be calculated exactly by simple counting methods and appropriate
assumptions. For example in tossing a fair coin the probability of a head is 50% or 0.5. This is because
there are only two equally likely outcomes. We would say that the chance is 1 out of 2, or 1/2 = 0.5.
This example suggests a simple definition of probability in the case where all events are equally likely:
Pr(event) =
Example 3-1
In one roll of a fair 6 sided die (singular of dice) what is:
(a) Pr(6)
(b)
Pr(even number)
(c) Pr(number less than 5)
(d)
Pr(2 and 4)?
Solution
(a)
(b)
(c)
(d)
Pr(6) = 1/6
Pr(even number) = 3/6 =0.5
Pr(number < 5) = 4/6 = 2/3
Pr(2 and 4) = 0/6 = 0
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Introduction to Probability
Note that, as in the above example, probabilities are positive proper fractions, that is probabilities are
numbers between 0 and 1 (inclusive). However in everyday language we may also convert them to
percentages.
3.2
Tree Diagrams
As events become more complicated we need some special methods to help us count the number of
different events. A simple visual method is the tree diagram. For tossing a fair coin the diagram looks
like this:
The total number of events equals the number of branches at the end of the (horizontal!) tree. For a fair
coin this is 2.
Example 3-2
Draw a tree diagram for the random event of rolling a fair die.
Solution
Tree diagrams are especially useful when two or more events take place together or successively.
Example 3-3
Two fair coins are tossed. How many outcomes are there? How many of these have 1 head and 1 tail?
Solution
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There are four outcomes, namely: {H,H}, {H,T}, {T,H} and {T,T}. Of these, two have one head and
one tail. Hence
Pr(1 head and 1 tail) = 2/4 = 0.5
Note that in this example the sum of the four probabilities, each equal to one quarter (= 0.25), is 1. This
is always true for the complete collection of outcomes that make up one random experiment.
Basic properties of probabilities:
(i) probabilities are greater than or equal to zero and less than or equal to 1, ie 0 pi 1
(ii) the sum of all possible probabilities is one, ie
pi = 1 .
3.3
No. of
customers
20
26
34
20
100
Solution
Pr(Comm) = 26/100 = 0.26, as each person has the same chance of selection in random sampling.
Hence each person is equally likely to be selected.
3.4
3.4.1
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Introduction to Probability
Example 3-5
For the bank customer data in Example 3-4 find the complement of:
(a) {Bonza} and (b) {Bonza, Melb} and the probabilities of these complements.
Solution
(a)
The
complement
of
{Bonza}
(b)
{Comm,
Natty,
=
=
=
=
1
1 Pr({Bonza})
1 20/100
0.8
Melb}.
3.4.2
is
=
=
=
1 Pr({Bonza, Melb})
1 40/100
0.6
However the following two events are not mutually exclusive: {1, 2, 3, 4} and {2, 4, 6}, as they have
both 2 and 4 in common. This means that if, with one roll of the die, we get, say, a 4 then both events
have occurred.
In Australian Rules football scoring has two mutually exclusive outcomes: a goal and a behind. (A
behind is a near miss of the goal on either side.)
Example 3-6
Which of the following are mutually exclusive pairs of events?
(a)
(b)
(c)
(d)
(e)
(f)
Solution
(a), (c) and (f) are mutually exclusive pairs of events.
If two events are mutually exclusive then Pr(either one or the other occurs) = Pr(one) + Pr(other). If we
denote two events using the letters A and B then if they are mutually exclusive
Pr(A or B) = Pr(A) + Pr(B)
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Example 3-7
For one roll of a fair die, what is the probability of a 2 or a 4?
Solution
We can calculate Pr(2 or 4) as 2/6 by the counting method, as there only two numbers in the event. But
since {2} and {4} are mutually exclusive and Pr(2) = 1/6 = Pr(4) then
Pr(2 or 4) = 1/6 + 1/6 = 2/6
In the bank data of Example 3-4, as each of the 100 customers belongs to only one bank the total
frequency is 100 and belonging to a bank gives four mutually exclusive events. Example 3-4(b) we can
calculate the probabilities in this way:
and
Consider the following table. One hundred people were asked which charities they supported.
Charity
Frequency
Salvation Army
44
Smith Family
35
Heart Foundation
22
Deaf and Blind
24
Guide Dogs
28
total
153
As the total is more than 100 some people are supporting more than one charity. Hence this is not a set
of mutually exclusive events and it would be incorrect to say, for example,
Pr({Salvation Army or Smith Family})
3.4.3
Independent Events
This is a quite different type of relationship to mutually exclusive as the property of independence is
conferred by the physical method of performing the events. The basic method for guaranteeing
independence is to select the items at random. This means that the selection of any one particular item
has no influence on what other items will be selected.
Some simple examples of random events that are independent are:
Tossing a fair coin several times. Each toss is (physically) independent of previous tosses as
these cannot affect the outcome of any later toss. So if the first toss is a head on the second toss
heads and tails are equally likely.
Rolling two fair dice together. Whatever comes up on one face cannot affect the other. Of
course the two dice may collide but this can only lead to an accidental change in the numbers.
There is no systematic effect such as if one is an even number then the other must be an odd
number.
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Introduction to Probability
Two weeks Tattslotto numbers. The numbered balls are thoroughly mixed and each one is
selected at random. The numbers selected in one week have no effect on which numbers are
selected in subsequent weeks.
Using a computer program that generates random numbers, to select individuals for a survey.
This method is used to randomly select telephone numbers for opinion polls.
Example 3-8
Which of the following pairs of events are independent and which are not independent?
(a)
(b)
(c)
(d)
Solution
(a) and (c) are independent. (b) and (d) are (probably) dependent.
Example 3-9
In one toss of a fair coin we get 10 straight heads. On the next toss is tails more likely than heads?
Solution
No! As each toss is independent of all other tosses then heads and tails are equally likely at every toss,
regardless of what has happened before.
If two events are independent then the probability that both happen together can be calculated from their
individual probabilities. Call two events A and B. If A and B are independent events then:
Pr(A and B) = Pr(A).Pr(B)
Example 3-10
Two fair coins are tossed together. What is the probability that both coins show a head?
Solution
Since Pr(head) = 0.5 for each coin, and the coins are tossed independently of each other then:
Pr(2 heads) = 0.5x0.5 = 0.25.
This agrees with, and supplements, the tree diagram analysis in example 3.3.
3.4.4
Conditional Probability
If two events are not independent then they are dependent. In this case the probability of one event
occurring is affected by whether or not the other related event has occurred. Related events are often
displayed in crosstabulations where two variables are measured for a set of individuals.
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Example 3-11
A Bondi Beach nightclub has the following data on the age and marital status of 140 customers:
Age
Single
Under 30
77
30 and over
28
14
21
Marital Status
Married
(a)
(b)
(c)
(d)
(e)
Solution
In this table we have recorded the age and marital status of 140 people. Each cell gives a different
combination of age and marital status. For example there are 14 people aged under 30 who are married.
(a)
Age
Single
Under 30
0.55
30 and over
0.20
0.10
0.15
Marital Status
Married
(b)
(c)
(d)
(e)
(f)
This question asks for a conditional probability. The condition is that the customer is under
30. This means that we must go back to the original table and only consider the under 30
column of the age variable.
Age
Single
Under 30
77
Marital Status
Married
14
There are 91 customers under 30. Hence the (conditional) probability that a customer is single, given
that they are under 30, is 77/91 = 0.846. Since the unconditional probability that a customer is single is
0.75 (from (c)) this shows that being single and being under 30 are not independent as these two
probabilities are not equal.
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Introduction to Probability
3.5
32
10
1
43
$25,000 to
$45,000
3
18
10
31
> $45,000
TOTAL
0
21
5
26
35
49
16
100
One employee is selected at random and two events are defined as follows:
A: The employee is under 30
B: The employees salary is under $25,000.
Express each of the following probabilities in words and find their numerical values:
(a) Pr(A)
(b) Pr(B
(c) Pr(A and B)
(d) Pr(A or B)
(e) Pr(A occurs given that B occurs)
(g) Find the probability that the employees salary is at least $25,000 given that the employee is at least
30 years of age.
(h) Are events A and B mutually exclusive?
(i) Are events A and B independent events?
Solution
(a) Pr(A) = 35/100 = 0.35
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Example 3-13
Note: The solutions to each part of this question will be given immediately after the question part.
Bendigo Power Generation Pty Ltd (BPG) is currently starting work on a project designed to increase
the generating capacity of one of its plants in the Bendigo District of Central Victoria. The project is
divided into two sequential stages: stage 1 (design) and stage 2 (construction). While each stage will be
scheduled and controlled as closely as possible, management cannot predict beforehand the exact
elapsed time for each stage of the project. An analysis of similar construction projects over the past 3
years has shown completion times for the design stage of 2, 3, or 4 months and completion times for the
construction stage of 6, 7, or 8 months.
(a) Draw a tree diagram for the BPG project, including a listing of all possible outcomes.
(b) Based on their experience and judgment, management concluded that the experimental outcomes
were not equally likely. By conducting a study of the completion time for similar projects
undertaken by BPG over the past three years management found the data on the next page.
Using this data, calculate the probabilities associated with each sample point and add these
probabilities to the tree diagram (on next page).
Completion time (months)
Stage 1
Stage 2
Sample Point
2
2
2
3
3
3
4
4
4
6
7
8
6
7
8
6
7
8
(2,6)
(2,7)
(2,8)
(3,6)
(3,7)
(3,8)
(4,6)
(4,7)
(4,8)
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Introduction to Probability
6
7
8
2
0.15
0.15
0.05
3
0.10
0.20
0.05
4
0.05
0.10
0.15
(c) Due to the critical need for additional power, management has set a goal of 10 months for the total
project completion time. Hence the entire project will be completed late if the total elapsed time to
complete both stages exceeds 10 months. What is the probability that the project will be finished on
time, that is, in 10 months or less?
Pr(on time) = (0.15 + 0.15 + 0.05) + (0.10 + 0.20) + 0.05 = 0.70
We can add these probabilities because they are all mutually exclusive outcomes.
(d) What is the most likely or most probable completion time?
Pr(8 months) = 0.15
Pr(11 months) = 0.15
3.6
3.6.1
Random Variables
In the previous sections and exercises the examples were concerned with random events and the
probabilities of the different outcomes of these events. For example in one toss of a fair coin there were
two outcomes, Head and Tail, each with probability 0.5; in Example 3-4 people were customers of one
of four banks and the probability of being a customer of each bank was calculated from the frequencies.
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In all these examples we have two things: a random variable, namely the outcome of a random
experiment, and a set of probabilities corresponding to each of the outcomes. When we combine these
two we have the probability distribution of the random variable.
In our examples in this section probability distributions will be displayed as a table, as in Example 3-14.
This is because all the random variables are discrete ie the outcomes are all distinct numbers or
categories. (Random variables can also be continuous, in which case a graph or table is used to
represent the probability distribution. An important example is discussed in section 4 below.)
Random variables are given a single letter name such as X or Y. Thus in one toss of a fair coin X is the
outcome, either a head or a tail.
Example 3-14
(a) What is the probability distribution for one toss of a fair coin?
Tossing a fair coin
x
Pr(x)
Head
0.5
(b) What is the probability distribution for one roll of a fair die?
Rolling a fair Die
1
2
x
1/6
1/6
Pr(x)
Tail
0.5
3
1/6
4
1/6
5
1/6
6
1/6
What is the probability of getting a number greater than 4? Name the probability rule that you need
to calculate this probability.
Pr(X > 4) = Pr(5) + Pr(6) = 1/6 + 1/6 = 2/6 = 1/3. Since 5 and 6 are mutually exclusive events we
can add the individual probabilities.
(c) Students in a university residence visit a nearby Pizza Parlour with varying frequencies per month.
Let X be the number of times a student visits the Pizza Parlour each month. The probability
distribution of X could look like this:
x
Pr(x)
0
0.1
1
0.3
2
0.4
3
0.2
If a student is selected at random find the probability that he/she will visit the Pizza Parlour:
i) No times.
Pr(X = 0) = 0.1
ii) Once.
Pr(X = 1) = 0.3
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Introduction to Probability
3.6.2
(c)
In these graphs it is the top of the vertical lines that represents the probabilities. The rest of the line is
drawn only to make the point more visible.
3.6.3
= E ( X ) = X . Pr( X )
The variance of a numerical random variable X is often written Var(X). For a discrete random variable,
Var ( X ) = E ( X 2 ) 2
The standard deviation is
Var ( X )
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Example 3-16
Calculate the mean value of the result of one roll of a fair die.
Solution
1
6
1
6
1
6
1
6
1
6
= E ( X ) = X . Pr( X ) = 1 + 2 + 3 + 4 + 5 + 6
1 21
=
= 3.5
6 6
The average of all the faces is 3.5, which can be seen by adding the numbers from 1 to 6 and then
dividing by 6.
Example 3-17
What is the average number of times per month that a student (from Example 3-14(c)) goes to the Pizza
Parlour?
Solution
The average number of times per student is the expected value of X.
Enter the values of X and Pr(X) given on p.13 so that your spreadsheet
appears as shown below.
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Introduction to Probability
Step 2:
Calculating the
expected value
To calculate the expected value we need to first multiply the outcome (X)
of each event in column 1 by its probability Pr(X) in column 2 of the
spreadsheet. Therefore, go to cell C2 and type = a2*b2 and press ENTER.
To copy this formula to the other cells in column C, right-click cell C2 and
select Copy from the resulting drop-down menu. Then press the Shift key,
scroll down with the left mouse button so that C3 to C5 are also
highlighted, right-click the mouse again, and select Paste.
Your
spreadsheet should then appear as shown below.
We now need to add the values in column C since the expected value is the
sum
X . Pr( X )
We will do this in row 7 of the spreadsheet here. First, type E(X) in cell
A7 so we can keep track of our calculations. Then, in cell B7, type
=sum(c2:c5) and press ENTER, to obtain the result below.
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Step 3:
Calculating
E( X 2 )
To calculate X^2 for the first outcome (X) in row 2, go to cell D2 and type
=a2^2 and press ENTER.
Then copy this formula to the other cells in column D by right-clicking cell
D2 and selecting Copy from the resulting drop-down menu. Press the Shift
key, scroll down with the left mouse button so that D3 to D5 are also
highlighted, right-click the mouse again, and select Paste.
Hence E ( X 2 ) = 3.7
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Introduction to Probability
Step 4:
calculating the
variance
We will now calculate Var(X) in row 9, so type Var(X) in cell A9. Since
Var ( X ) = E ( X 2 ) 2 and we calculated E ( X 2 ) in cell B8 and in cell
B7, go to cell B9 and type =b8-b7^2 and press ENTER.
Example 3-19
A company operates a chain of takeaway food outlets. It intends to build an additional outlet and
surveys the following possible locations:
Ringwood
Footscray
St. Kilda
Probability of
Success
0.6
0.4
0.5
Estimated Profit
if Successful
$35,000
$60,000
$45,000
Estimated Profit
if Unsuccessful
$2,500
$7,000
$6,000
Which location should be chosen? Consider both the expected profit and the risk involved as measured
by the standard deviation.
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Solution
For each location we can calculate the expected value of the profit from the probability distribution. For
Ringwood the distribution is:
x (profit $)
35,000
2,500
0.6
0.4
Pr(x)
The probability of failure is 1 0.6 = 0.4 as failure is the complement of success.
For Footscray the distribution is:
x (profit $)
Pr(x)
60,000
0.4
7,000
0.6
45,000
0.5
6,000
0.5
We obtain the three expected profits and standard deviations individually, using Microsoft Excel as in
Example 3-18.
Location
Ringwood
Footscray
St.Kilda
Coeff of variation
72%
92%
76%
Hence we could choose Footscray as it is the most profitable location but noting that the expected profit
is the most variable and hence the most risky. St Kilda is a compromise with the second highest
expected profit but the second lowest risk as measured by the coefficient of variation.
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Introduction to Probability
3.7
References:
Anderson, D.R, et al Statistics for Business and Economics, Australian edition 1989.
Chapter 4, pages 79 - 107
Chapter 5, pages 125 - 132
Levine, D. M. Krehbiel, T. C., Berenson, M. L./ Business Statistics: A First Course, Second Edition
2000, Prentice Hall.
Chapter 4, pages 154 170, 179 - 183
McLean, A., Stephens, B., Business Mathematics and Statistics, Longman 1996.
Chapter 20, pages 451 477
Chapter 21, pages 488 494
Selvanathan, A., Selvanathan, S., Keller, G., Warrack, B., Australian Business Statistics, Abridged third
edition, Nelson 2004.
Chapter 4, pages 114 140
Chapter 5, pages 182 190
Event
Definition of probability of an event
Complement
Addition Law
Multiplication Law
Discrete random variable
Probability function
Standard deviation
USEFUL FORMULAE:
Pr(event ) = 1 Pr(complement )
E(X) = = xp(x)
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3.8
Exercises
Exercise Set 3A Calculating Probabilities (Solutions can be found on page
266)
1. Over a long period of time, the queue length of customers at the teller section of a major bank was
observed to have the following probability distribution;
Number in queue
Probability
0
0.1
1
0.2
2
0.2
3
0.3
4 or more
0.2
(c)
(d)
(e)
Given there is at least one person in the queue, what is the probability that there are 4 or
more?
2. An airline has offered a special vacation package to Fiji. The length of stay is either for 3 days or 7
days, and the type of accommodation can be either economy, regular, or deluxe. Consider the
experiment of observing the choices made by the next person signing up for the package.
(a)
(b)
3. An investor has two stocks: stock A and stock B. Each stock may increase in value, decrease in value,
or remain unchanged. Consider the experiment as the investment in both of the two stocks.
(a)
(b)
(c)
How many of the experimental outcomes result in an increase in value for at least one of the
two stocks?
(d)
How many of the experimental outcomes result in an increase in value for both of the
stocks?
4. Suppose that a manager of a large apartment complex provides the following subjective probability
estimates about the number of vacancies that will exist next month:
Vacancies
0
1
2
3
4
5
Probability
.05
.15
.35
.25
.10
.10
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Introduction to Probability
List the components of each of the following events and calculate the probability of the events:
(a)
No vacancies.
(b)
(c)
5. The manager of a furniture store sells from zero to four china cabinets each week. Based on past
experience, the following probabilities are assigned to sales of zero, one, two, three, or four cabinets:
Pr(0) = 0.08
Pr(1) = 0.18
Pr(2) = 0.32
Pr(3) = 0.30
Pr(4) = 0.12
1.00
(a)
(b)
Let A be the event that two or fewer are sold in one week. Find Pr(A).
(c)
Let B be the event that four or more are sold in one week. Find Pr(B).
6. A sample of 100 customers of the Adelaide Gas and Electric Company resulted in the following
frequency distribution of monthly charges.
Amount $
0-49
50-99
100-149
150-199
200-249
Number
13
22
34
26
5
(a)
Let A be the event that monthly charges are $150 or more. Find Pr(A).
(b)
Let B be the event that monthly charges are less than $150. Find (Pr(B).
7. A survey of 50 students at a technical college regarding the number of extracurricular activities resulted
in the following data
Number of Activities
Frequency
0
8
1
20
2
12
3
6
4
3
5
1
(a)
Let A be the event that a student participates in at least 1 activity. Find Pr(A).
(b)
Let B be the event that a student participates in 3 or more activities. Find Pr(B).
(c)
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8. A garage sells from 0 to 4 car batteries each week. Based on past experience, the following probabilities
are assigned to sales of 0, 1, 2, 3 or 4 batteries.
(a)
Pr(0) = 0.19
Pr(1) = 0.24
Pr(2) = 0.35
Pr(3) = 0.14
Pr(4) = 0.08
1.00
Are these valid probability assignments? Why or why not?
(b)
Let A be the event that two or fewer are sold in one week. Find Pr(A).
(c)
Let B be the event that four or more are sold in one week. Find Pr(B).
(d)
Are A and B mutually exclusive? Find Pr(A and B) and Pr(A or B).
9. A purchasing agent has placed two rush orders for a particular raw material from two different suppliers,
A and B. If neither order has arrived in 4 days the production process must be shut down until at least
one of the orders arrives. The probability that supplier A can deliver the material in 4 days is 0.55. The
probability that supplier B can deliver the material in 4 days is 0.35. Draw a tree diagram to help you
answer the following questions.
(a)
What is the probability that both suppliers deliver the material within 4 days? Since two
separate suppliers are involved we are willing to assume independence.
(b)
What is the probability that the production process is shut down in 4 days because of a
shortage in raw material (that is, both orders are late)?
(c)
What is the probability that at least one supplier delivers the material in 4 days?
10. To install a pool fence, a company responds to all sales inquiries by first sending a brochure. It then
attends the property to measure and quote, and finally installs the fence. It classifies the outcome of all
sales inquiries into three mutually exclusive categories depending on how far the customer progresses in
the inquiry:- request for brochure; measure and quote given; and pool fence purchased. From its records
for the last 6 months it has extracted the result of all inquiries and the suburb of the customer. The
results are summarised in the table below.
Request
for
brochure
Measure
and
quote
Fence purchased
Total
Eastern suburbs
100
Western suburbs
50
Other
50
Total
200
50
10
20
80
50
200
0
60
20
90
70
350
(a)
What is the probability that a sales contact results in a pool fence sale?
(b)
What is the probability that a sales inquiry from a person in the Eastern suburbs results in a
pool fence sale?
(c)
What is the probability that a measure and quote inquiry comes from the Eastern or Western
suburbs?
(d)
Are the events 'Request for brochure' and 'client is from the Eastern suburbs' independent?
Give a reason for your answer.
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Introduction to Probability
Exercise Set 3B Discrete Probability Distributions (Solutions can be found on page 30)
1. The heights of the Hawthorn Basketball Club team playing next week (including injury replacements)
are:
Height (cm)
No. of Players
170
1
175
2
180
2
185
2
190
1
195
4
200
1
205
2
210
1
(a)
(b)
(c)
Find the probability distribution of this random variable. Determine the expected height of a
Hawthorn Basketball Club team member using Microsoft Excel.
2. The demand for a product of Gippsland Industries varies greatly from month to month. Based on the
past 2 years of data, the following probability distribution shows the companys monthly demand.
300
0.20
Unit demand
Probability
400
0.30
500
0.35
600
0.15
(a)
If the company places monthly orders based on the expected value of the monthly demand,
what should Gippslands monthly order quantity be for this product?
(b)
Assume that each unit demanded generates $70 in revenue and that each unit ordered costs
$50. How much will the company gain or lose in a month if it places an order based on your
answer to part (a) and where the actual demand for the item is 300 units?
(c)
3. An investor has a certain amount of money available to invest now. Three alternative portfolio
selections are available. The estimated profits of each portfolio under three economic conditions are
shown in the table below.
Event
Economy declines
No change
Economy expands
A
$500
$1,000
$2,000
Portfolio Selection
B
-$2,000
$2,000
$5,000
(a)
(b)
(c)
C
-$7,000
-$1,000
$20,000
Probability
0.3
0.5
0.2
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4. Consider the state of the economy. There are three possible changes in the economy between this year
and next. For each type of change the probability and likely return are given in the following table.
State of Economy
Recession
Stable
Boom
Probability of State
p(x)
0.25
0.5
0.25
Construct a probability distribution, with the random variable (X) equivalent to the net
return.
(b)
(c)
6. The demand for a dried fish product which is a specialty of Tran Trung Industries varies greatly from
month to month. Based on the past three years of data, the following probability distribution shows the
companys monthly demand.
Demand (kgs)
Probability
200
0.15
300
0.30
400
0.40
500
0.15
(a)
If the company prepares monthly production on the basis of the expected value of the
monthly demand, what quantity of dried fish should Tran Trung Industries prepare?
(b)
Assume that each kilogram of fish demanded generates $25 in revenue and that each
kilogram of dried fish produced costs $17. How much will the company gain or lose if its
monthly production is based on your answer from (a) and the actual demand for the product
is 300 kgs?
7. The J.R. Ryland Computer Company is considering a plant expansion that will enable the company to
begin production of a new computer product. The companys managing director must determine
whether to make the expansion a medium or large-scale project. An uncertainty involves the demand for
the new product, which for planning purposes may be low demand, medium demand, or high demand.
The probability estimates for the demands are .20, .50 and .30, respectively. Letting X and Y indicate
the annual profit in $1,000s, the firms planners have developed profit forecasts for the medium and
large-scale expansion projects.
Expansion Profits
Demand
Low
Medium
High
Medium-scale
x
Pr(x)
50
0.20
150
0.50
200
0.30
Large-scale
y
Pr(y)
0
0.20
100
0.50
300
0.30
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Introduction to Probability
(a)
Compute the expected value for the profit associated with the two expansion alternatives.
Which decision is preferred for the objective of maximising the expected profit?
(b)
Compute the standard deviation for the profit associated with the two expansion alternatives.
Which decision is preferred for the objective of minimising the risk or uncertainty?
ANSWERS TO EXERCISES
Exercises 3A Answers
1. (i)
(ii)
Pr(X 3) = Pr(X 2) + Pr(3) = 0.5 + 0.3 = 0.8 OR Pr(X 3) = 1 Pr( 4) = 1 0.2 = 0.8
(iii)
(iv)
(v)
Pr(X 4 | X 1) =
Pr( X 4) 0.2
= 0.22
=
Pr( X 1) 0.9
2. (a)
Number of outcomes = No. of nights stay No. of accommodation types = 2 3 = 6
possible outcomes
(b)
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3. (a)
(b)
(c)
(d)
1 = (,)
4. (a)
Pr(X = 0) = 0.05
(b)
(c)
5. (a)
Yes. All the probabilities are between 0 and 1 (0 pr(x) 1)and the sum of the
probabilities is 1 (pr(x) = 1).
(b)
(c)
6. (a)
(b)
26 + 5 31
=
= 0.31
100
100
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Introduction to Probability
7. (a)
Pr(A) = Pr(X 1) =
20 + 12 + 6 + 3 + 1 42
=
= 0.84
50
50
(b)
Pr(B) = Pr(X 3) =
6 + 3 + 1 10
=
= 0.2
50
50
(c)
Pr(X = 2) =
12
= 0.24
50
8. (a)
Yes. All the probabilities are between 0 and 1 (0 pr(x) 1)and the sum of the
probabilities is 1 (pr(x) = 1).
(b)
(c)
(d)
9.
(a)
(b)
(c)
Pr(At least one on time) = Pr(OT, OT) + Pr(OT, L) + Pr(L, OT) = 0.1925 + 0.3575 + 0.1575
= 0.7075
OR Pr(At least one on time ) = 1 Pr(both late) = 1 0.2925 = 0.7075
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10.
(a)
(b)
(c)
(d)
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Introduction to Probability
EXERCISE 3B Answers
Probability distribution.
Height
170
175
180
185
190
195
200
205
210
(cm)
Probability 0.0625 0.125 0.125 0.125 0.0625 0.25 0.0625 0.125 0.0625
Enter the height and the corresponding probabilities in two columns. To calculate the expected
value we need to first multiply the height of each in column 1 by its probability in column 2 of
the spreadsheet. Therefore, go to cell C2 and type = a2*b2 and press ENTER
Thus the expected height of a Hawthorn basketball club member is 190 centimetres.
a
b
Expected value=445
Revenue = 300 @ $70
= $21,000
Cost = 445 @ $50 = $22,250
Profit/Loss
= ($1,250)
Standard deviation=97.34
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Highest expected return are Portfolios A and B, with an expected return of $1,400.
Lowest risk (as measured by the standard deviation) is Portfolio A with $522.
It depends on what one is looking for in an investment. Portfolio B has a good return and
medium risk, while Portfolio A has minimum risk but a lower return. Portfolio C offers a
good return with very high risk.
Thus the expected return is 15% and the standard deviation is 14% (Note the coefficient of
variation = 0.1414/0.15 = 94.27%, thus there is a great deal of uncertainty associated with
the returns).
Net return
$ (x)
Pr(x)
4999
1999
999
499
-1
0.0001
0.0001
0.0001
0.0003
0.9994
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Introduction to Probability
Expected loss is 5 cents. A person is unlikely to win, but if one does, there are good returns.
A conservative gambler may be comfortable buying a ticket for such a small outlay (but
would be more cautious if the ticket cost say $100).
Expected value=$355
b
Higher expected return is for the medium scale expansion, with an expected return of
$145,000.
The standard deviations are $52,200 and $111,360 respectively. Lowest risk (as measured
by the standard deviation) is the medium scale expansion. Most of the times we should
calculate Coefficient of Variation but in this case expected returns for each investment are
close hence we are looking at the standard deviations.
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