Professional Documents
Culture Documents
DBM
Quantitative Techniques in Management
Semester - 1
Session - 3
Random Experiment
Outcomes
Flipacoin
Heads,Tails
ExamMarks
Numbers:0,1,2,...,100
AssemblyTime
t>0seconds
CourseGrades
F,D,C,B,A,A+
Probabilities
Sample Space
A list of exhaustive [dont leave anything out] and mutually
exclusive outcomes [impossible for 2 different events to
occur in the same experiment] is called a sample space
and is denoted by S.
The outcomes are denoted by O1, O2, , Ok
Using notation from set theory, we can represent the
sample space and its outcomes as:
Requirements of Probabilities
Classical Approach
If an experiment has n possible outcomes [all equally
likely to occur], this method would assign a probability
of 1/n to each outcome.
Experiment: Rolling a die
Sample Space:
S = {1, 2, 3, 4, 5, 6}
Probabilities: Each sample point has a 1/6 chance of
occurring.
What about randomly selecting a student and observing
their gender? S = {Male, Female}
Are these probabilities ?
Classical Approach
Experiment: Rolling 2 die [dice] and summing 2
What are the
numbers on top.
underlying, unstated
Sample Space: S = {2, 3, , 12} assumptions??
Probability Examples:
1
2
3
4
5
6
P(2) = 1/36
1
2
3
4
5
6
7
P(7) = 6/36
P(10) = 3/36
10
10
11
10
11
12
Relative Frequency
Approach
DesktopsSold
#ofDays
2
From this we can construct
the estimated probabilities of an event 3
(i.e. the # of desktop sold on a given day)
4
10
12
5
#ofDays
DesktopsSold
2/30 = .07 =
P(X=1)
10
10/30 = .33 =
P(X=2)
12
12/30 = .40 =
P(X=3)
5/30 = .17 =
P(X=4)
3
4
= 1.00
There is a 40% chance Bits & Bytes will sell
3 desktops on
any given day [Based on estimates obtained from sample of
30 days]
Subjective Approach
In the subjective approach we define probability
as the degree of belief that we hold in the
occurrence of an event
P(you drop this course)
P(NASA successfully land a man on the moon)
P(girlfriend says yes when you ask her to marry
you)
Interpreting Probability
One way to interpret probability is this:
If a random experiment is repeated an infinite number of
times, the relative frequency for any given outcome is
the probability of this outcome.
For example, the probability of heads in flip of a
balanced coin is .5, determined using the classical
approach. The probability is interpreted as being the
long-term relative frequency of heads if the coin is
flipped an infinite number of times.
Example
Why are some mutual fund managers more successful
than others? One possible factor is where the manager
earned his or her MBA. The following table compares
mutual fund performance against the ranking of the school
where the fund manager earned their MBA: Where do we
get these probabilities from? [population or sample?]
Mutual fund outperforms
the market
.11
.29
.06
.54
Example
B1
B2
A1
.11
.29
A2
.06
.54
E.g.P(A2andB1)=.06
=theprobabilityafundoutperformsthemarket
andthemanagerisntfromatop20school.
Marginal Probabilities
Marginal probabilities are computed by adding across rows and down columns; that
is they are calculated in the margins of the table:
P(A2)=.06+.54
whatstheprobabilityafund
managerisntfromatopschool?
B1
B2
P(Ai)
A1
.11
.29
.40
A2
.06
.54
.60
P(Bj)
.17
.83
1.00
P(B1)=.11+.06
whatstheprobabilityafund
outperformsthemarket?
BOTHmarginsmustaddto1
(usefulerrorcheck)
Conditional Probability
Conditional probability is used to determine how two
events are related; that is, we can determine the
probability of one event given the occurrence of another
related event.
Experiment: random select one student in class.
P(randomly selected student is male) =
P(randomly selected student is male/student is on 3 rd
row) =
Conditional probabilities are written as P(A | B) and read
as the probability of A given B and is calculated as:
Conditional Probability
Again, the probability of an event given that another
event has occurred is called a conditional probability
Conditional Probability
Whats the probability that a fund will
outperform the market given that the
manager graduated from a top-20 MBA
program?
Recall:
A1 = Fund manager graduated from a top-20 MBA program
A2 = Fund manager did not graduate from a top-20 MBA program
B1 = Fund outperforms the market
B2 = Fund does not outperform the market
Conditional Probability
We want to calculate
P(BB12 | A1)
B1
P(Ai)
A1
.11
.29
.40
A2
.06
.54
.60
P(Bj)
.17
.83
1.00
Thus,thereisa27.5%chancethatthatafundwilloutperformthemarket
giventhatthemanagergraduatedfromatop20MBAprogram.
Independence
One of the objectives of calculating conditional
probability is to determine whether two events are
related.
In particular, we would like to know whether they are
independent, that is, if the probability of one event is
not affected by the occurrence of the other event.
Two events A and B are said to be independent if
Independence
For example, we saw that
P(B1 | A1) = .275
The marginal probability for B1 is: P(B1) = 0.17
Since P(B1|A1) P(B1), B1 and A1 are not independent
events.
Stated another way, they are dependent. That is, the
probability of one event (B1) is affected by the occurrence of
the other event (A1).
Union
A1orB1occurswhenever:
A1andB1occurs,A1andB2occurs,orA2andB1occurs
B1
B2
P(Ai)
A1
.11
.29
.40
A2
.06
.54
.60
.17
.83
1.00
P(Bj)
P(A1 or B1) = .11 + .06 + .29 = .46
Example
Addition Rule
Addition Rule
B1
B2
P(Ai)
A1
.11
.29
.40
A2
.06
.54
.60
P(Bj)
.17
.83
1.00
(A1 or B1) = P(A) + P(B) P(A and B) = .40 + .17 - .11 = .46
Example
Bayes Law
Bayes Law is named for Thomas Bayes, an
eighteenth century mathematician.
In its most basic form, if we know P(B | A),
we can apply Bayes Law to determine P(A | B)
P(B|A)
P(A|B)
forexample
Bayesian Terminology
The probabilities P(A) and P(AC) are called prior
probabilities because they are determined
prior to the decision about taking the
preparatory course.
The conditional probability P(A | B) is called a
posterior probability (or revised probability),
because the prior probability is revised after the
decision about taking the preparatory course.
Transplant operations for hearts have the risk that the body may reject the
organ. A new test has been developed to detect early warning signs that the
body may be rejecting the heart. However, the test is not perfect. When the
test is conducted on someone whose heart will be rejected, approximately
two out of ten tests will be negative (the test is wrong). When the test is
conducted on a person whose heart will not be rejected, 10% will show a
positive test result (another incorrect result). Doctors know that in about
50% of heart transplants the body tries to reject the organ.
*Suppose the test was performed on my mother and the test is
positive (indicating early warning signs of rejection). What is the
probability that the body is attempting to reject the heart?
*Suppose the test was performed on my mother and the test is negative
(indicating no signs of rejection). What is the probability that the body is
attempting to reject the heart?
PROBABILITY DISTRIBUTIONS
Random Variable
Answer:
0.16 + 0.18 + 0.22 + 0.10 + 0.3 + 0.01 =
0.97 <1 , Not a probability distribution.
Mean=0*0.06+1*0.58+2
*0.22+3* 0.1+4
*0.03+5*0.01
= 1.49
EXAMPLE
The variance=(0-1.49)^2*0.06+(11.49)^2*0.58
+(2-1.49)^2*0.22+(3-1.49)^2*0.1
+(4-1.49)^2*0.03+(5-1.49)^2*0.01
=0.8699
Standard Deviation= 0.932684
Practice Problem:
x
P(x
)
10
.4
11
.2
12
.2
13
.1
14
.1
b.
c.
p(x=14)= .1
Practice Problem:
Poisson
Counts (e.g., how many cases of disease in a
given area)
Continuous case
The probability function that accompanies a
continuous random variable is a continuous
mathematical function that integrates to 1.
The probabilities associated with
continuous functions are just areas under
the curve (integrals!).
Probabilities are given for a range of values,
rather than a particular value (e.g., the
probability of getting a math SAT score
between 700 and 800 is 2%).
Continuous case
For example, recall the negative
exponential function (in probability, this
is called an exponential distribution):
f ( x) e x
This function integrates to 1:
e
0
0 1 1
E( X )
x p(x )
i
all x
Continuous case:
E( X )
xi p(xi )dx
all x
x
i 1
i 1
1
xi ( )
n
Variance, formally
Discrete case:
Var ( X )
2
(x )
i
p(xi )
all x
Continuous case:
Var ( X ) ( xi ) p ( xi )dx
2
Practice Problem
A roulette wheel has the numbers 1
through 36, as well as 0 and 00. If you bet
$1.00 that an odd number comes up, you
win or lose $1.00 according to whether or
not that event occurs. If X denotes your
net gain, X=1 with probability 18/38 and
X= -1 with probability 20/38.
We already calculated the mean to be = $.053. Whats the variance of X?
Answer
2
(x )
p(xi )
all x
(1 .053) 2 (18 / 38) (1 .053) 2 (20 / 38)
.997 .99
Standard deviation is $.99. Interpretation: On average, youre
either 1 dollar above or 1 dollar below the mean, which is just
under zero. Makes sense!
Var ( X )
(x )
i
p(xi )
all x
p(xi ) ( )
all x
E ( x ) [ E ( x)]
2
Intervening algebra!
Examples of discrete
probability distributions:
The binomial and Poisson
distributions
Binomial example
Take the example of 5 coin tosses. Whats
the probability that you flip exactly 3 heads
in 5 coin tosses?
Binomial distribution
Solution:
One way to get exactly 3 heads: HHHTT
Whats the probability of this exact arrangement?
P(heads)xP(heads) xP(heads)xP(tails)xP(tails)
=(1/2)3 x (1/2)2
Another way to get exactly 3 heads: THHHT
Probability of this exact outcome = (1/2)1 x (1/2)3 x
(1/2)1 = (1/2)3 x (1/2)2
Binomial distribution
In fact, (1/2)3 x (1/2)2 is the probability of
each unique outcome that has exactly 3
heads and 2 tails.
So, the overall probability of 3 heads and 2
tails is:
(1/2)3 x (1/2)2 + (1/2)3 x (1/2)2 + (1/2)3 x (1/2)2
+ .. for as many unique arrangements as
there arebut how many are there??
5
3
ways to
arrange 3
heads in
5 trials
C3 = 5!/3!2! = 10
Outcome
Probability
THHHT
(1/2)3x(1/2)2
HHHTT
(1/2)3x(1/2)2
TTHHH
(1/2)3x(1/2)2
HTTHH
(1/2)3x(1/2)2
HHTTH
(1/2)3x(1/2)2
THTHH
(1/2)3x(1/2)2
HTHTH
(1/2)3x(1/2)2
HHTHT
(1/2)3x(1/2)2
THHTH
(1/2)3x(1/2)2
HTHHT
(1/2)3x(1/2)2
10 arrangements x (1/2)3x(1/2)2
The probability
of each unique
outcome (note:
they are all
equal)
3
2
P(3 heads and 2 tails) = xP(heads)
xP(tails)
=
3
10x()5=31.25%
For a Poisson
random variable,
the variance and
mean are the
same!
where = expected number of hits in a given
time period
e
p( X k )
k!
Example
For example, if new cases of West Nile
Virus in New England are occurring at a
rate of about 2 per month, then these are
the probabilities that: 0,1, 2, 3, 4, 5, 6, to
1000 to 1 million to cases will occur in
New England in the next month:
P(X)
2 0 e 2
0!
2 1 e 2
=.135
=.27
1!
2 2 e 2
2!
=.27
2 3 e 2
=.18
3!
2 4 e 2
4!
=.09
more on Poisson
Poisson Process (rates)
Note that the Poisson parameter can be given as
the mean number of events that occur in a defined
time period OR, equivalently, can be given as a
rate, such as =2/month (2 events per 1 month) that
must be multiplied by t=time (called a Poisson
Process)
X ~ Poisson ()
( t ) k e t
P( X k )
k!
E(X) = t
Var(X) = t
Example
For example, if new cases of West Nile
in New England are occurring at a rate
of about 2 per month, then whats the
probability that exactly 4 cases will
occur in the next 3 months?
X ~ Poisson (=2/month)
( 2 * 3) 4 e ( 2*3) 6 4 e ( 6 )
P(X 4 in 3 months)
13.4%
4!
4!
Exactly 6 cases?
( 2 * 3) 6 e ( 2*3) 6 6 e ( 6 )
P(X 6 in 3 months)
16%
6!
6!
Practice problems
1a. If calls to your cell phone are a Poisson
process with a constant rate =2 calls per
hour, whats the probability that, if you
forget to turn your phone off in a 1.5 hour
movie, your phone rings during that time?
1b. How many phone calls do you expect to
get during the movie?
Answer
1a. If calls to your cell phone are a Poisson process with a
constant rate =2 calls per hour, whats the probability that, if
you forget to turn your phone off in a 1.5 hour movie, your
phone rings during that time?
X ~ Poisson (=2 calls/hour)
P(X1)=1 P(X=0)