QAM I by Prof Gaurav Garg (IIM Lucknow) Quantitative Analysis

Quantitative Analysis for
Management - I
http://ganga.iiml.ac.in/~ggarg/QAM1.html
QAM - I by Prof. Gaurav Garg (IIM Lucknow)
EVALUATION SCHEME
Quiz: 10%
Impression: 5%
Mid Term Exam: 35%
Post Mid part (OR): 50%
EXAM DATES
Quiz: 19 Jul 2011;
8:30 - 8:50 AM
Mid Term Exam: 1 - 3 Aug 2011
(Exact date and timings will be announced later)
CONTACT HOURS
Thursday & Friday 5:00 PM - 6:00 PM
COURSE OUTLINE
Random Variable
Discrete Probability Distributions
Continuous Probability Distributions
Correlation and Regression
Introduction to Sampling
CONTACT DETAILS
234, Chintan
Indian Institute of Management Lucknow
Prabandh Nagar, Off Sitapur Road
Lucknow - 226 013, Uttar Pradesh, INDIA
Talk: +91-522-273-6627 (W), +91-522-273-6416 (R)
Email: ggarg@iiml.ac.in; ggarg31@gmail.com
Random Variable
A Review of Probability Theory
Random Experiment is an experiment

which results in any one of the possible
outcomes, though repeated under identical
conditions. Actual result can not be
predicted.
Sample Space is an exhaustive list of all

the possible outcomes of a random
experiment.
The repetitions of the experiment are known

as trials.
All the possible outcomes in any trial are

together known as exhaustive events.
The outcomes favorable to an event in a trial

are called as favorable outcomes.
Events are said to be mutually exclusive or

disjoint, if the happening of any one of them
rules out the happening of all the others. No
two or more of them can happen
simultaneously.
The events are said to be equally likely, if

there is no reason to expect one in
preference to the others.
The events are said to be independent, if

the happening of an event does not affect
the happening of any other event.
The event A occurs and the event A does

not occur are called complementary
events to each other.
The event A does not occur is denoted by A

c

or A.
Classical Definition of Probability
S is a sample space
A is some event in S. ( )
n
A
is the number of occurrences of A
n is the total number of outcomes.
The Probability of event A is
Limitations:
outcomes should be equally likely
total no. of outcomes should be finite.

S A
n
n
A P
A
) (
Relative Frequency Definition of

Probability
The probability of an event A is
Limitations
outcomes should be equally likely
the limit should exist

n
n
A P
A
n
lim ) (

Axiomatic Definition of Probability
S is a sample space
A is some event in S. ( )
A number P(A) is assigned to the event A
P(A) is called the probability of the event A ,

if it satisfies following 3 axioms:
S A

+
B A B
B P A P B A P
S P
A P
provided , event any for
) ( ) ( ) ( (iii)
1 ) ( (ii)
1 ) ( (i)
Important Probability Rules
If S is a sample space, then
P(S) = 1
P() = 0
If A is some event in S, then
A A
c
= , so P(A A
c
) = 0
AUA
c
= S so P(AUA
c
) = 1
P(A
c
) = 1 P(A)
Addition Law of Probability
P(AUB) = P(A) + P(B) P(A B)
P(AUB) = P(A) + P(B), provided AB =
AB = means A and B are mutually

exclusive
Conditional probability
Probability of A given that B has already

occurred is
P(A|B) = P(AB)/ P(B)
Joint Probability of A and B is
P(AB) = P(A|B) . P(B) or
P(AB) = P(B|A) . P(A)
When A and B are independent events,

then
P(A|B)=P(A)
P(AB)=P(A).P(B)
Example:
Each year, ratings are complied concerning the

performance of new cars during first 90 days of use.
Cars are categorized according to
if the car needs warranty related repair
If the car is manufactured in USA
Based on the data collected, it was found that
P(Car needs warranty repair) = 0.04
P (Car manufactured in USA) = 0.60
P (needs warranty repair and manufactured in USA)

= 0.025
Make contingency table
Obtain the probability that
A new car needs warranty repair or manufactured

in USA
A new car needs warranty repair and not

manufactured in USA
Example:
In a lot of used cars
70% have air conditioning (AC)
40% have a CD player (CD)
20% of the cars have both.
What is the probability that a car has a CD

player, given that it has AC ?
We want to find P(CD | AC).

CD No CD Total
AC 0.2 0.5 0.7
No AC 0.2 0.1 0.3
Total 0.4 0.6 1.0
H
a
s

A
C
D
o
e
s

n
o
t

h
a
v
e

A
C
H
a
s

C
D
D
o
e
s

n
o
t

h
a
v
e

C
D
H
a
s

C
D
D
o
e
s

n
o
t

h
a
v
e

C
D
P
(
A
C
)
=

0
.
7
P
(
A
C
)
=

.
3
P(AC and CD) = 0.2
P(AC and CD
/
) = 0.5
P(AC and CD
/
) = 0.1
P(AC and CD) = 0.2
1 . 1
1 . 1
1 . 1
1 . 1
1 . 1
1 . 1
All
Cars
1 . 1
1 . 1
Given AC or
no AC:
H
a
s

C
D
D
o
e
s

n
o
t

h
a
v
e

C
D
H
a
s

A
C
D
o
e
s

n
o
t

h
a
v
e

A
C
H
a
s

A
C
D
o
e
s

n
o
t

h
a
v
e

A
C
P
(
C
D
)
=

0
.
4
P
(
C
D
)
=

0
.
6
P(CD and AC) = 0.2
P(CD and AC) = 0.2
P(CD and AC) = 0.1
P(CD and AC) = 0.5
1 . 1
1 . 1
1 . 1
1 . 1
1 . 1
1 . 1
All
Cars
Given CD or
no CD:
1 . 1
1 . 1
Idea of Random Variable
Consider a random experiment of

tossing a fair coin twice.
Suppose a person plays a game where
he wins Rs. 100 if he gets at least

one head in two tosses, and
he loses Rs. 200 otherwise.
If the person keeps playing the game

for a long time, is he going to gain
some money or loose?
What is the long term gain or loss to

the person.
The probability of getting at least one

head in two tosses is
P({HH, HT ,TH})=3/4.
So he has 75% chance of winning Rs.

100.
But, at the same time, he could lose Rs.

200 with 25% chance.
Now how to incorporate this idea of his

gain (or loss) along with the probability.
In many situations, Probability fails to

provide the quantitative measurement
of the uncertainty.
What is lacking in previous example, is

some quantitative measurement of his
gain.
We define X as his gain or profit in the

same game, then
X takes the value 100 when he wins.
X takes the value -200 when he

looses.
Now each of these outcomes is a part

of the sample space.
So each of them has some specific

probability to happen.
We write it more systematically as

follows
Using the corresponding probabilities,

we write the same idea as
Or
This variable X is called random

variable.
Variable changes its values

depending on some other factor
(unlike constant).
Random Variable changes its value

depending on what we get as an
outcome of a random experiment.
Thus, each value of a random

variable is associated with a
probability.
In other words, random variable

takes a value with some probability.
Mathematical Definition
A random variable is a function that assigns

a numeric value to the outcomes of a
random experiment
i.e., X : S R,
where S is the sample space, R is the real line

(-, ).
Example:
Consider the random experiment of tossing two coins
Sample space: S = {HH, HT, TH, TT }
X is number of Heads appeared
X is a random variable
X can take any value out of 0,1 and 2.
P(X =0) = P{TT} = 1/4,
P(X =1) = P{HT ,TH} = 2/4,
P(X =2) = P{HH} = 1/4.

Example:
Consider the random experiment of tossing a

fair die.
Sample space: S = {1, 2, 3, 4, 5, 6}
P(getting 1) = 1/6 P(getting 2) = 1/6
Let X be the value on the upper face of the

die
X could be 1, 2, 3, 4, 5 or 6
The event of getting 1 is same as saying

X=1
So, P(getting 1) = P(X=1) = 1/6
Similarly, P(X=2) =1/6,
P(X=3) = 1/6, P(X=4) = 1/6,
P(X=5) = 1/6, P(X=6) = 1/6

Example:
Consider the random experiment of tossing

a fair coin thrice.
Sample space
S={HHH, HHT, HTH, THH, HTT, THT, TTH, TTT}
X: no. of heads appearing in three tosses
X is a random variable.
X could be 0, 1, 2, or 3.
P(X = 0) = P(TTT) = 1/8
P(X=1) = P(HTT, THT, TTH) = 3/8
P(X=2) = P(HHT, HTH, THH) = 3/8
P(X=3) = P(HHH) = 1/8

Consider the same example again.
S = {HHH, HHT, HTH, THH, HTT, THT, TTH, TTT}
X: no. of heads appearing in three tosses
X belongs to {0, 1, 2, 3}
Event of getting at least one head is

same as X 1
P(X 1) = P(HHH, HHT, HTH, THH, HTT, THT, TTH)
= 7/8
Similarly, we can write
P(X 1) = P(HTT, THT, TTH, TTT) = 4/8
P(X < 2) = P(HTT, THT, TTH, TTT) = 4/8
P(X 2) = P(HHT, HTH, THH, HTT, THT, TTH, TTT)= 7/8

Example:
Consider the random experiment of drawing

two cards at random from a well shuffled pack of
52 cards.
The sample space: S = { CC, CD, CH, CS,

DC, DD, DH, DS,
HC, HD, HH, HS,
SC, SD, SH, SS }
X: number of Diamond Cards selected
X is a random variable.
X 1 is the event that at most one diamond is

selected
P(X 1) = 15/16
P(X = a) is the probability that X takes on the

value a
P(X a) is the probability that X takes on a value

that is less than or equal to a
Example:
Metro trains run every half hour between

7:00 AM to 7:00 PM on a certain line .
A man enters the station at a random time

during this period.
Let X be the random variable which denotes

the waiting time in minutes.
X can take any value between 0 and 30.
Sample space: S = [0,30].
The event that he has to wait for at most

10 minutes is same as X 10
P(X 10) = (10 0)/ (30 0) = 1/3

Types of Random Variables
Random Variables are of two types:
Discrete Random Variable
Continuous Random Variable
Discrete Random Variable takes only a

countable (finite or countably innite) number
of values.
no. of accounts opened,
no. of cars sold,
Friday night attendance at a cinema,
no. of defective bulbs in a box, etc.
Discrete random variables usually count the

items. is
Range set of X is the collection of all possible

values of X
Range set of a discrete random variable is

countable.
Continuous Random Variable takes on

any values within an interval.
weight of fertilizer packed in a bag,
amount of sugar in an orange,
time required to run a mile,
price of a stock, etc.
Continuous random variable is usually a

measurement.
It can take an uncountably infinite number of

values.
Range set of a continuous random variable is

an interval.
It can be of types (-, ), (-, 0), (0, ) or (a, b).

More Examples
Random Variable Values Type
Flip a coin three times;
X = the total number of heads.
Select a mutual fund;
X = the number of companies in
the fund portfolio.
Measure the length of an
object;
X = its length in centimeters.
Throw two dice over and
over until you roll a double
six;
X = the number of throws.
Take a true-false test with
100 questions; X = no. of
questions answered correctly.
Invest $10,000 in stocks;
X = the value, to the nearest
$1, of your investment after an
year.
Select a group of 50 people
at random;
X = exact average height (in m)
of the group.
{0, 1, 2,
3}
{2, 3,
4, ...}
Any positive
number
{ 1, 2, 3,
4, ...}
{0, 1, 2, 3,
4, ..., 100}
{$0, $1, $2,
$3,}
Any positive
number
Range Set is Finite
Range Set is Countably
Infinite
Range Set is Uncountable
Infinite
Range Set is Finite
Infinite
Range Set is Uncountable
Probability Distribution of a Discrete
Random Variable
Also called as Probability Mass Function

(pmf).
It is a mutually exclusive listing of all possible

values of the discrete random variable along
with corresponding probabilities.
p
1
, p
2
, p
3
,. are non-negative.
Together they sum up to 1.

All possible values of random variable X
Corresponding probabilities
Example:
X is the number of heads appeared in two coins

tossing experiment.
X is a discrete random variable having the probability

distribution
'
1 if , 1 / 1
1 if , 1 / 1
1 if , 1 / 1
) (
is of function mass y probabilit
x
x
x
x p
X
x = 0 x = 1 x = 2
P
r
o
b
a
b
i
l
i
t
i
e
s
Example:
In throwing a die, X is the values appeared
X is a discrete random variable having the probability

distribution
. 1 , 1 , 1 , 1 , 1 , 1 if , 1 / 1 ) (
x x p
X
x=1 x=2 x=3 x=4 x=5 x=6
P
r
o
b
a
b
i
l
i
t
i
e
s
Recall the first example where X is the

random variable denoting the gain and is
given by
In tabular format, the probability distribution

of X is given by
Probability mass function of X is written as

'
111 if 1 / 1
111 if 1 / 1
) (
x
x
x p
Sometimes, the pmf can be

expressed as a mathematical function.
Example:
X denotes the number of tosses

needed to get the first tail.
X is a discrete random variable.

So the random variable X has the probability

distribution
probability mass function p(x) can also be

written as
Also,
1
1
1
1
1
1
1
1
1
1
1
1
1
1
) (
1 1
1 1

,
_
,
_
,
_
x
x x
x p
( )
( )
'

1 if 1 / 1
1 if 1 / 1
1 if 1 / 1
) (
1
1
x
x
x
x p
X
Example:
Consider the previous example again.
The discrete random variable has the pmf
The probability of getting a tail in less than 3

tosses is given by
P(X < 3) = P(X=1) + P(X=2)

= p(1) + p(2)
= (1/2) + (1/2)
2
=1/2 + 1/4
= 3/4
Example:
Suppose an individual purchases two

electronic components
Each of which may either be defective or

acceptable.
Sample space: S = {DD, DA, AD, AA}
Given that P(DD) = 0.09, P(DA) = 0.21,
P(AD) = 0.21, P(AA) = 0.49.
X: number of acceptable components.
Obtain the probability distribution of X.
What is the probability of getting at least

one acceptable components?
Ans: 0.91
Expectation of a Discrete Random
Variable
X is a discrete random variable having the

pmf p(x)
Expectation or Expected value or mean of X

is given by
Recall the first example where X is the

random variable denoting the gain
pmf of X is
Expected gain of the person is
E(X) = (100)(3/4) + (-200)(1/4) = 25

Rupees
'
111 if 1 / 1
111 if 1 / 1
) (
x
x
x p
Expectation of a random variable can be

interpreted as some sort of average
of all the values that the random variable
takes.
So, expected value of a random variable is

the center of its distribution.
The concept of expectation is analogous to

the physical concept of the center of
gravity of a distribution of mass.
If a and b are constants; and X and Y are

random variables, then we have
E(a) = a,
E(aX) = aE(X),
E(ax + bY) = aE(X) + bE(Y).

Example
Suppose X is a discrete random variable

having following probability distribution
Find E(X).
Ans: -0.6
Example
A shipment of 6 television sets contains 2

defective sets.
A hotel makes a random purchase of 3 of the

sets.
If X is the no. of defective sets purchased by

the hotel.
How many defective sets are expected?
Ans: 1
x -2 -1 0 1
p(x) 0.4 k 0.2 0.3
Example
Consider the random experiment of tossing

a fair coin.
What is the expected number of tosses

Recall the example discussed earlier.
Random variable X is the number of tosses

pmf of X is given as
We have to find E(X)
Ans: 2
Variance of a Discrete Random
Variable
The idea of center is not enough to

summarize a probability distribution.
We need some idea of variability also.
Variance of a random variable X is

defined as
It is the expected squared deviation of

possible values of X from its mean. QAM - I by Prof. Gaurav Garg (IIM Lucknow)
( ) { }
( ) [ ]
1
1
1
1
) (
) ( ) (
X E X E
X E X E X Var
X

where p(x) is the pmf of X.
Note that Variance is always non-negative.

Standard Deviation of X =
x
= [Var (X)]
If a and b are constants, X and Y are

random variables, then we have
Var(a) = 0,
Var(aX) = a
2
Var(X),
Var(aX + bY) = a
2
Var(X) + b
2
Var(Y) + 2ab
XY

XY
is the covariance between X and Y.
(will be discussed
later)
), ( ) ( and ) ( ) (
1 1
x p x X E x p x X E
x x

Example
Suppose X is a discrete random variable

having following probability distribution
Find Var(X).
Ans: 1.64
Example
A shipment of 6 television sets contains 2

defective sets.
A hotel makes a random purchase of 3 of the

sets.
If X is the no. of defective sets purchased by

the hotel.
Find Var(X).
Ans: 2/5
x -2 -1 0 1
p(x) 0.4 k 0.2 0.3
Joint Probability Distribution of two
Discrete Random Variables
Let X and Y be two discrete random variable
Joint probability distribution or joint

probability mass function of X and Y is
X
Y
b
1
b
2
b
m
Total
a
1
p
11
p
12
p
1m
p
1.
a
2
p
21
p
22
p
2m
p
2.
.
.
.
.
.
.
.
.
.
.
.
.
a
n
p
n1
p
n2
p
nm
p
n.
Totalp
.1
p
.2
p
.m
1
. , , 1 , 1 ; , , 1 , 1 ), and ( m j n i b Y a X P p
j i ij

Marginal pmf of X
Marginal pmf of Y
Possible values of X
Possible values of Y
Example:
A fair coin is tossed once.
Let X denote the number of heads.
Y denote the number of tails.
Find the joint probability mass function

of X and Y.
Ans
Y
X 0 1 Total
0 0 1/2 1/2
1 1/2 0 1/2
Total 1/2 1/2 1
Example:
A fair coin is tossed three times

independently.
X: no. of heads on the first toss;
Y: total no. of heads.
Find the joint pmf of X and Y.
Ans
Y
X 0 1 2 3 Total
0 1/8 2/8 1/8 0 4/8
1 0 1/8 2/8 1/8 4/8
Total 1/8 3/8 3/8 1/8 1
Covariance between two
Discrete Random Variables
X and Y are two discrete random variables.
Covariance is a measure of strength of

relationship between X and Y.
It is given by
Here,
[ ]
) ( ) ( ) (
)} ( )}{ ( {
Y E X E XY E
Y E Y X E X E
XY

m
j
j j
n
i
i i
n
i
m
j
ij j i
p b Y E p a X E
p b a XY E
1 1
1 1
) ( , ) (
) (
Example:
A fair coin is tossed three times

independently.
Let X denote the no. of heads on the

first toss;
Y denote the total no. of heads.
Obtain covariance between X and Y.

Example:
A fair coin is tossed once.
Let X denote the number of head.
Y denote the number of tail.
Obtain covariance between X and Y.

Example:
Given the following probability distribution

for the random variables X and Y
Compute
E(X), E(Y), E(X+Y)

X
,
Y
,
XY
Var (X+Y) = Var (X) + Var (Y) + 2
XY
= ?
P(X
i
Y
i
) X Y
0.2 -100 50
0.4 50 30
0.3 200 20
0.1 300 20
Independence of two Discrete Random
Variables
Two discrete random variables X and Y

are said to be independent of each
other when
p
ij
= (p
i.
) (p
.j
) for i = 1,2,,n and j =
1,2,,m.
When X and Y are independent, then

covariance between them is zero.
i.e.,
XY
= 0.
This implies that when X and Y are

independent,
E(XY) = E(X).E(Y)
Probability Distribution of a
X is continuous random variable.

Range set R
x
of X is an interval on the
real line.
X can take infinite number of values

and they are always uncountable.
We can not assign a probability to each

possible value.
pmf is defined only for points x
1
, x
2
,
Point probability p(x) becomes

meaningless in this case.
The probability distribution of a continuous

random variable is given by probability
density function (pdf)
pdf is defined as
Provided
,
_
+

1 1
1
lim ) (
1
h
x X
h
x P
h
x f
h
. 1 and all for , 1 ) (
X
R
f(x) dx x x f
Consider a continuous random variable

X.
pdf of X is f(x) with range set R
x
Probability that X takes the values on

an interval (a,b) or (a,b] or [a,b) or [a,b] is
given by

<
< < <
b
a
dx x f
b X a P
b X a P
b X a P b X a P
) (
) (
) (
) ( ) (
Example:
Let X is a random variable with probability

density function given by
Show that f (x) is a valid pdf.
Find P(X > 2) and P(1 < X < 2).

Example:
Let X is a random variable with pdf
Show that f (x) is a valid pdf.
Find P(X > 1/2) and P(0 < X < 1/2).

Expectation of a Continuous Random
Variable
If X is a continuous random variable.
The probability density function of X is f(x).

The range space of X is R
X
.
Then the Expectation of X is given by
Example:
If X is a continuous random variable with pdf

f(x) = a e
-ax
, a > 0, x > 0.
Find E(X).
Ans: 1/a
X
R
dx x xf X E ) ( ) (
Example:
If X is a continuous random variable

with pdf
Find E(X).
Ans: 3/4
Example:
If X is a continuous random variable

with pdf
f(x) = k, 0 < X < 2,
Find k
Find E(X)
Variance of a Continuous Random
Variable
X is a continuous random variable.
where
f(x) is pdf of X,
R
X
is the range space of X.

X X
R R
dx x xf X E dx x f x X E ) ( ) ( and ) ( ) (
1 1
( ) { }
( ) [ ]
1
1
1
1
) (
) ( ) (
X E X E
X E X E X Var
X

Example:
Find Var(X).
Example:
f(x) = 1/2, 0 < X < 2,
Find Var(X)
Example:

f(x) = a e
-ax
, a > 0, x > 0.
Find Var(X).
Summary
Random Variable

o
Probability mass function of a discrete random
variable
o
Expectation of a discrete random variable
o
Variance of a discrete random variable
o
Joint probability mass function
o
Covariance between two variables
o
Independence of two random variables

o
Probability density function of a continuous
random variable
o
Expectation of a continuous random variable
o
Variance of a continuous random variable

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Quantitative Analysis for

Random Experiment is an experiment

Sample Space is an exhaustive list of all

The repetitions of the experiment are known

All the possible outcomes in any trial are

The outcomes favorable to an event in a trial

Events are said to be mutually exclusive or

The events are said to be equally likely, if

The events are said to be independent, if

The event A occurs and the event A does

The event A does not occur is denoted by A

Classical Definition of Probability

n is the total number of outcomes.

The Probability of event A is

outcomes should be equally likely

total no. of outcomes should be finite.

Relative Frequency Definition of

The probability of an event A is

outcomes should be equally likely

the limit should exist

Axiomatic Definition of Probability

A number P(A) is assigned to the event A

P(A) is called the probability of the event A ,

If S is a sample space, then

If A is some event in S, then

Addition Law of Probability

P(AUB) = P(A) + P(B) P(A B)

P(AUB) = P(A) + P(B), provided AB =

AB = means A and B are mutually

Probability of A given that B has already

P(A|B) = P(AB)/ P(B)

Joint Probability of A and B is

P(AB) = P(A|B) . P(B) or

P(AB) = P(B|A) . P(A)

When A and B are independent events,

Each year, ratings are complied concerning the

Cars are categorized according to

if the car needs warranty related repair

If the car is manufactured in USA

Based on the data collected, it was found that

P(Car needs warranty repair) = 0.04

P (Car manufactured in USA) = 0.60

P (needs warranty repair and manufactured in USA)

Make contingency table

Obtain the probability that

A new car needs warranty repair or manufactured

A new car needs warranty repair and not

In a lot of used cars

70% have air conditioning (AC)

40% have a CD player (CD)

20% of the cars have both.

What is the probability that a car has a CD

We want to find P(CD | AC).

Consider a random experiment of

Suppose a person plays a game where

he wins Rs. 100 if he gets at least

he loses Rs. 200 otherwise.

If the person keeps playing the game

What is the long term gain or loss to

The probability of getting at least one

So he has 75% chance of winning Rs.

But, at the same time, he could lose Rs.