ECON1203/ECON2292

Business and Economic

Statistics

Week3

Administrivia
Thefirstfortnightlyquizwasputupon

MyStatLablastWednesday.Getontoit!
LearningCatalytics

Yourtutorwilluseitinyourtutorialworkshopthis
week(andwillprovidethesessionID)
Yourhomeworkwill(sometimes)useit

Week 3 topics
Introductiontoprobability
Probabilitydistributions

Marginal,conditionalandjointdistributions
Pdfsandcdfs
Examplesofhowtousethem

Probability
American professional football players have four times greater risk of
dying from ALS or Alzheimers. National Institute for Occupation Safety
and Health 2012.

Probabilityisthemathematicalmeansofstudying
uncertainty
Itprovidesthelogicalfoundationofstatisticalinference

Studyingprobabilityhelpsusmakejudgementcallstosupport
decisionsonthebasisofpartialinformation
E.g.:whatistheprobabilityofasell-outatanupcoming
concert,givendataonpastconcerts,weatherforecasts,etc.?
4

Probability

Tounderstandprobabilityformally,youneedto
understandwhatismeantby:

Independence
Mutualexclusivity
Joint,marginalandconditionalprobability
Countingrulescombinationsandpermutations

Inhighschool,youconcentratedonprobabilitiesof
individualevents/outcomes

Wewillconcentrateonprobability distributions
Aprobabilityisassignedtoeverypossibleoutcomewithina
sample space
5

Probability review

LeteandfbetwoeventsinasamplespaceS.

Ifeandfaremutually exclusive, thenthe

addition rulestates:

Then:P(e)0;P(f)0;P(S)=1

P(eUf)=P(e)+P(f)
SharpewritesP(eUf)asP(eorf)

Ifeandfarenotmutuallyexclusive,thenthe
general addition rule states: S

P(eUf)=P(e)+P(f)P(ef)
SharpewritesP(ef)asP(eandf)

e
6

Probability review

Oftenitseasiertoworkwiththeprobabilityof
theevent(orsetofevents)complementaryto
evente,whichwecallnot e,orec

Theideaofjoint probabilityiscapturedinthe
expression P(ef),writtenasP(eandf)

P(ec)=1P(e)

The multiplication ruleshowshowthisiscomputed

Tounderstandit,weneedtounderstandthe
ideaofconditional probability

InanySwheref hasalreadybeenobservedtooccur
ornotoccur,the(marginal)probabilitythateoccurs
7
maychange.Itmaygoupordown.

Probability review
Theconditionalprobabilitythateoccurs,

giventhatfhasoccurred,isdefinedby:

P(ef)=P(eandf)/P(f)
Similarly,P(f|e)=P(eandf)/P(e)

Rearrangingyields:

P(eandf)=P(e |f)P(f)
Thisisthemultiplicationrule

IfP(e

|f)=P(e)andP(f |e)=P(f),then:

Conditioninghasnoeffect
eandfaresaidtobeindependent events
8

Probability review
Recalltheconditionalprobabilitiesofeandf:
P(ef)=P(eandf)/P(f)andP(f|e)=P(eandf)/P(e)
Rearrangingbothyields:
P(eandf)=P(e |f)P(f);and(1)
P(eandf)=P(f|e)P(e).(2)
Nowsubstitute(1)into(2)andsolveforP(e |f):
Pe|f

P f | e P e
Pf

ThisisBayesRule!

Ifeandfareindependentevents,thisequationsimplifiesto:
P(e|f)=P(e).
Canyouseewhy?
9

An example

Supposewedrawastudentrandomlyfromthisclassandasktheir
height.
WethenringupmyfriendPaulandsay,heyPaul,withwhat
probabilitydoyouthinkthepersonwevepickedfromtheclassis
female?[uh,Idontknow..5?]Andwhatabouttheprobabilitythat
s/heislessthan160cmtall?[whyareyouaskingmethis?Idont
know,maybe.3?]
Thenwesay,OK,wellasithappens,thispersonis155cmtall.
Whatisyourrevisedguessabouttheprobabilitys/heisfemale?
[youarenuts.Maybe.8.Goodbye.]
P (female) = P(femaleless than 160 cm)
P (female | less than 160 cm) = P(female and less than 160 cm)
P(less than 160 cm)
P(female and less than 160 cm) = P(female)*P(less10than 160 cm)

Private health insurance

11

Private health insurance

12

Private health insurance

Whatistherelationshipbetweenhavingprivate
healthinsurance(PHI)andbeingadmittedto
hospitalasapublicorprivatepatient?
DatafromABS2001NationalHealthSurveywas
usedtoderivefollowingtableofrelativefrequencies:

13

Private health insurance

Treatrelativefrequencies
asprobabilities
Findtheprobabilityofthe
followingevents:

HavePHI
HavePHIandadmittedto
hospital
Admittedasaprivate
patient,givenhavePHI
Admittedasapublic
patient,givenhavePHI

Areadmittedasaprivate
patientandhavePHI
independentevents?
14

Private health insurance

Originaltabletreatedasa
joint bivariate distribution
ofadmissionandPHI
Whatisthemarginal
distribution ofhospital
admission?
Whatistheconditional
distributionofadmission
givenPHI?

15

Independence

Covarianceandcorrelationaremeasuresoflinear
associationorlineardependence

Dependence(anditsopposite,independence)isamore
generalconceptofassociationbetweentwovariables

SupposeadmissionandPHIwereindependent

Whatwouldweexpecttofindwhencomparingthe
marginaldistributionofadmissionwiththeconditional
distributiongivenhavePHI?
Isthatwhatwefind?
Whatarethepotentialconfoundingfactorsinthiscase?

16

Auditing example

Supposeyouworkatalocalauditingfirm

Yourfirmservices100companies
10ofthesecompaniesareknowntohaveoverdue
accounts

Iftwoofthese100clientfirmsarechosenat
randomfromtheclientlist,thenwhatisthe
probabilitydistributionapplicabletothat(small!)
samplefornumberofaccountsoverdue?

17

Auditing example
Let ei denote the i th firm having an overdue account.
P ( none overdue) P (e1C and e2C )
P (e1C ) P (e2C | e1C )
90

100

89

0.809
99

P (one overdue) P (e1C and e2 ) P (e1 and e2C )

90 10 10

100 99 100
P ( two overdue) 1 0.809 0.182

0.009

90

0.182
99
18

A tease on sampling

Thisexampleillustratesthedistinctionbetween
samplingwithandwithoutreplacement

Becausetheproblemimpliedthatfirmswerechosenatthe
sametime,samplingwasdonewithout replacement
Suchsamplinginducesdependenceacrossevents
P(e )dependsonthetypeoffirmsampledinthefirstdraw
2
(i.e.,onP(e1))
Independenceandhencerandomsamplingrequires
samplingwith replacement
Thisdistinctionisnotofpracticalimportanceifthepopulation
fromwhichwedrawthesampleislarge
Athome,re-dotheauditingexampleassumingsamplingwith
19
replacement

Probability trees

Eventsindrawssuchasthatmadeintheauditing
examplemayberepresentedbyprobability trees

Thesearediagrams(thatresembletrees)

Supposeweselect2studentswithoutreplacement
fromagroupof10students,ofwhom3arefemale
and7aremale:

20

Another example:
Gender composition

Supposeweareinterestedinthegender
compositionoffamilies

DefineX=numberofboysinfamilieswith3children

Assume:

ThusX=0,1,2or3
Birthoutcomesareindependentevents
Malesandfemalesareequallylikelytobeborn

WhatistheprobabilitydistributionofX?

Wehavedeterminedoutcomes,sonowweneedto
calculateassociatedprobabilities.
21

Gender composition
P ( X 0) P (FFF ) 0.5 .125
P ( X 1) P (MFF ) P (FMF ) P (FFM )
3

3 0.5 .375
3

Thisiscalledaprobability
distribution function(pdf)

P ( X 2) P (MMF ) P (MFM ) P (FMM )

.375
P ( X 3) P (MMM) .125

Notes:

Wecouldhaveusedaprobabilitytreetoisolatethe8outcomes
andtheirassociatedprobabilities
Theresultantprobabilitydistributionsatisfiestherequirements:

P(X =x)0forallx,and

P( X x ) 1
allx

22

Gender composition

Wecanalsorepresentdistributionsintermsofthe
cumulative distribution function(cdf)

DefinedasF(x)=P(X x)forallx

F(x)

0 ifx 0
0.125 0 x 1
0 .5 1 x 2
0.875 2 x 3
1
x3
23

Gender composition

Apdf or cdf canbeusedtodetermineprobabilities

ofspecificsetsofevents

WhatisP(0<X<3)?
P(0<X<3)=P(X=1)+P(X=2)=0.75
orP(0<X<3)=F(2)F(0)=0.8750.125=0.75
WhatisP(X>0)?
P(X>0)=1-P(X0)=1F(0)=0.875

Becareful!

P(X>0)P(X0)

24

Odds into probabilities

Portlandbet is excited to announce that betting is open on all
150 seats to be contested in the upcoming federal election
as well as on which party will form government after the
votes have been cast and counted

Odds?(at26/7/07)
Winpricesfor$1bet:$1.67ALP,$2.15Coalition
Letp =theprobabilityofanALPwin.Then,assumingthatthe
A
pricescomefromafairgame,
0.67pA - (1-pA)=0pA=1/1.67=0.599
But
1.15pc - (1-pc)=0pc=1/2.15=0.465 1-pA

Alsonotice0.599+0.465=1.064>1

25

Odds into probabilities

Whatshappening?

WecanshowthatprobabilitypA=0.563andtheprofit
marginofPortlandbetisabout6%
Thisexplainswhythebookiegoeshomeina
Mercedesandthepunteronabus

WhatifthewinpriceforALPwas$2andfor
Coalition$2.15?Takethebet!

Sumofreciprocalsis0.5+0.465=0.965<1
$100betoneachpartywouldyieldabreak-evenifthe
ALPwinsandaprofitof$15ifthecoalitiondoes
26

Review

Probability:Whatitisandhowtoworkwithit
Marginal,conditional,andjointprobability
Independence
Probabilitiesinaction
Ateaseaboutsampling(moredetailsupsoon)

27