Expected Value is what should happen, on average, per trial if there are many trials.

This is related to the Law of Large Numbers.

Expected Value = EV If xs represent all outcomes and p(x) represents the probability of x happening: EV = [xp(x)] This formula may look confusing, but it is actually really easy to use.

EV = [xp(x)] is the Greek capital letter sigma. It means take the sum. All you have to do is multiply every x times its p(x) and then add up all those products. That is how you find expected value EV!

Lets say I am going to play a game where I spin a wheel with five equal parts. On three spots I lose $5, one spot I gain $10, and one spot I gain $1. What is the expected value of my bet?

Each part of the wheel has a 1/5 = 0.2 probability of landing. Since the lose $5 takes up three parts P( $5) = 3/5 = 0.6 Gain $10 takes up one part. P(+$10) = 1/5 = 0.2 Same for the gain $1 P(+$1) = 1/5 = 0.2

Lets make a table: x Lose $5 5 Gain $10 10 Gain $ 1 1 EV = $ 0.80

p(x) x p(x) 0.6 5 0.6 = 3.0 0.2 10 0.2 = 2.0 0.2 1 0.2 = 0.2 0.8

What does EV = $ 0.80 mean? Does it mean that every time you play you will lose 80 cents? That cant be it because losing 80 cents is not an outcome.

Does it mean you will lose every time you play? It cant mean that because you can very easily win this game.

EV = $ 0.80 It means that if you play many times, on average you will lose approximately 80 cents for every time you played.

If you play 100 times, you can expect to lose 100($0.80) = $80 Is this guaranteed? Anything could happen. But, like the Law of Large numbers, the more trials, the more accurate the EV.

Although gambling is the obvious example, expected value is very useful and can be used in many important ways. Lets say you are a banker that is completing an investment.

Your consultants tell you that with this investment there is a 70% chance of profiting $10,000, a 20% of losing $30,000, and a 10% chance of breaking even. What is the expected value of the investment? Should the bank do it?

Lets make a table x p(x) x p(x) 10,000 0.7 10,000 0.7 = 7,000 30,000 0.2 30,000 0.2 = 6,000 0 0.1 0 0.1 = 0 1,000 EV = $1,000

Be careful what this means. It doesnt mean that the bank will profit $1,000 dollars on this investment. Every investment is different, so the bank can only make this investment once. It cant have many trials with this investment.

What investors can do is find the expected value of all their investments and only make investments that have positive expected values. They will profit from some and lose some, but, in the end, if all EVs are positive, they should make an overall profit.

Maybe some of the bankers should have paid attention when they took QMB 3600! If they only made investments that had a positive EV, then we would not be in this financial crisis!

Expected value does not always have to be about money. Lets say a sports apparel store sells Rays baseball caps. The manager estimates that if the Rays win the World Series, the store will sell 500 caps. If the Rays do not win the world series, the store will sell only 100 caps. The paper gives the Rays a 20% chance of winning the World Series. Try to find the EV!

Lets make a chart. x p(x) x p(x) win WS 500 0.2 500 0.2 = 100 not win WS 100 0.8 100 0.8 = 80 180 The EV = 180 caps

A principle of a high school has a concern. The Rays are in the Word Series and it is tied in the 9th inning. He knows that many of his students are watching the game an it is already midnight (since the games start so darn late). He feels that the later the game goes, the less students will make 1st period tomorrow morning.

His wife is a math teacher and she has the following estimates. If the game ends in: 9th Inning: 30 % chance, 600 students make first period 10th Inning: 40%, 500 students 11th Inning 20%, 300 students 12th Inning or later: 10% 200 students You try and find the EV!

x 9th 600 10th 500 11th 300 12th 200

x p(x) 600 0.3 = 180 500 0.4 = 200 300 0.2 = 60 200 0.1 = _20 460 EV = 460 students

p(x) 0.3 0.4 0.2 0.1