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PAN African e Network Project

DBM
Quantitative Techniques in Management

Semester - 1
Session - 3

Dr. Sarika Jain

Random Experiment

a random experiment is an action or


process that leads to one of several possible
outcomes. For example:
Experiment

Outcomes

Flipacoin

Heads,Tails

ExamMarks

Numbers:0,1,2,...,100

AssemblyTime

t>0seconds

CourseGrades

F,D,C,B,A,A+

Probabilities

List the outcomes of a random experiment


List: Called the Sample Space
Outcomes: Called the Simple Events

This list must be exhaustive, i.e. ALL possible outcomes


included.
Die roll {1,2,3,4,5}
Die roll {1,2,3,4,5,6}

The list must be mutually exclusive, i.e. no two outcomes can


occur at the same time:
Die roll {odd number or even number}
Die roll{ number less than 4 or even number}

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:

S = {O1, O2, , Ok}

Requirements of Probabilities

Given a sample space S = {O1, O2, , Ok}, the


probabilities assigned to the outcome must satisfy
these requirements:

(1) The probability of any outcome is between 0 and 1

i.e. 0 P(Oi) 1 for each i, and


(2) The sum of the probabilities of all the outcomes
equals 1

i.e. P(O1) + P(O2) + + P(Ok) = 1


P(Oi)representstheprobabilityofoutcomei

Approaches to Assigning Probabilities


There are three ways to assign a probability, P(Oi), to
an outcome, Oi, namely:
Classical approach: make certain assumptions (such
as equally likely, independence) about situation.
Relative frequency: assigning probabilities based on
experimentation or historical data.
Subjective approach: Assigning probabilities based
on the assignors judgment. [Bayesian]

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

Bits & Bytes Computer Shop tracks the number of desktop


computer systems it sells over a month (30 days):
For example,
10 days out of 30
2 desktops were sold.

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

Relative Frequency Approach


DesktopsSold[X]

#ofDays

DesktopsSold

1/30 = .03 =P(X=0)

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)

Events & Probabilities


An individual outcome of a sample space is called a
simple event [cannot break it down into several
other events],
An event is a collection or set of one or more simple
events in a sample space.
Roll of a die: S = {1, 2, 3, 4, 5, 6}
Simple event: the number 3 will be rolled
Event: an even number (one of 2, 4, or 6) will be rolled

Events & Probabilities


The probability of an event is the sum of the
probabilities of the simple events that constitute the
event.
E.g. (assuming a fair die) S = {1, 2, 3, 4, 5, 6} and
P(1) = P(2) = P(3) = P(4) = P(5) = P(6) = 1/6
Then:
P(EVEN) = P(2) + P(4) + P(6) = 1/6 + 1/6 + 1/6 = 3/6
= 1/2

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.

Joint, Marginal, Conditional


Probability

We study methods to determine probabilities of events


that result from combining other events in various
ways.
There are several types of combinations and
relationships between events:
Complement of an event [everything other than that
event]
Intersection of two events [event A and event B] or [A*B]
Union of two events [event A or event B] or [A+B]

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

Mutual fund doesnt


outperform the market

Top 20 MBA program

.11

.29

Not top 20 MBA program

.06

.54

E.g. This is the probability that a mutual


fund outperforms AND the manager
was in a top-20 MBA program; its a
joint probability [intersection].

Example

Alternatively, we could introduce shorthand notation to represent the events:


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

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

P( A and B) = P(A)*P(B/A) = P(B)*P(A/B) both are true


Keep this in mind!

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

Thus, we want to know what is P(B1 | A1) ?

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

P(A|B) = P(A) and P(B|A) = P(B)


P(you have a flat tire going home/radio quits working)

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

Determine the probability that a fund outperforms (B1)

or the manager graduated from a top-20 MBA program (A1).

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

Probability Rules and Trees


We introduce three rules that enable us to calculate the
probability of more complex events from the probability of
simpler events
The Complement Rule May be easier to calculate the
probability of the complement of an event and then
substract it from 1.0 to get the probability of the event.
P(at least one head when you flip coin 100 times)

= 1 P(0 heads when you flip coin 100 times)


The Multiplication Rule: P(A*B) way I write it
The Addition Rule: P(A+B) way I write it

Example

A graduate statistics course has seven male and three


female students. The professor wants to select two students
at random to help her conduct a research project. What is the
probability that the two students chosen are female?
P(F1 * F2) = ???
Let F1 represent the event that the first student is female
P(F1) = 3/10 = .30
What about the second student?
P(F2 /F1) = 2/9 = .22
P(F1 * F2) = P(F1) * P(F2 /F1) = (.30)*(.22) = 0.066
NOTE: 2 events are NOT independent.

Addition Rule

Addition rule provides a way to compute the


probability of event A or B or both A and B
occurring; i.e. the union of A and B.

P(A or B) = P(A + B) = P(A) + P(B) P(A and B)


Why do we subtract the joint probability P(A and
B) from the sum of the probabilities of A and B?
P(AorB)=P(A)+P(B)P(AandB)

Addition Rule

P(A1) = .11 + .29 = .40

P(B1) = .11 + .06 = .17


By adding P(A) plus P(B) we add P(A and B) twice. To correct we
subtract P(A and B) from P(A) + P(B)

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

Addition Rule for Mutually Excusive Events


If and A and B are mutually exclusive the occurrence
of one event makes the other one impossible. This
means that

P(A and B) = P(A * B) = 0


The addition rule for mutually exclusive events is

P(A or B) = P(A) + P(B)

Only if A and B are Mutually Exclusive.

Example

In a large city, two newspapers are published, the Sun


and the Post. The circulation departments report that 22%
of the citys households have a subscription to the Sun
and 35% subscribe to the Post. A survey reveals that 6%
of all households subscribe to both newspapers. What
proportion of the citys households subscribe to either
newspaper?
That is, what is the probability of selecting a household at
random that subscribes to the Sun or the Post or both?
P(Sun or Post) = P(Sun) + P(Post) P(Sun and Post)
= .22 + .35 .06 = .51

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.

Students Work Bayes Problem


The Rapid Test is used to determine whether someone
has HIV [H]. The false positive and false negative rates
are 0.05 P(+/ Hc) and 0.09 P(-/H) respectively.
The doctor just received a positive test results on one
of their patients [assumed to be in a low risk group for
HIV]. The low risk group is known to have a 6% P(H)
probability of having HIV. What is the probability that this
patient actually has HIV [after they tested positive]. Feel
free to use a table to work this problem
P(H) = 0.06
**** P(Hc) = ?
P(+/ Hc) = 0.05
**** P(-/ Hc) = ?
P(-/H) = 0.09
**** P(+/H) = ?

Students Work Bayes Problem

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

A random variable x takes on a defined set of values with different


probabilities.
For example, if you roll a die, the outcome is random (not fixed)
and there are 6 possible outcomes, each of which occur with
probability one-sixth.
For example, if you poll people about their voting preferences,
the percentage of the sample that responds Yes on
Proposition 100 is a also a random variable (the percentage
will be slightly differently every time you poll).

Roughly, probability is how frequently we expect different outcomes to


occur if we repeat the experiment over and over (frequentist view)

Random variables can be


discrete or continuous
Discrete random variables have a
countable number of outcomes
Examples: Dead/alive, treatment/placebo,
dice, counts, etc.

Continuous random variables have an


infinite continuum of possible values.
Examples: blood pressure, weight, the
speed of a car, the real numbers from 1 to
6.

A probability distribution provides the


possible values of the random variable and
their corresponding probabilities. A
probability distribution can be in the form of
a table, graph or mathematical formula.

The table below shows the probability distribution


for the random variable X, where X represents
the number of DVDs a person rents from a video
store during a single visit.

EXAMPLE Identifying Probability Distributions

Is the following a probability distribution?

Answer:
0.16 + 0.18 + 0.22 + 0.10 + 0.3 + 0.01 =
0.97 <1 , Not a probability distribution.

EXAMPLE The Mean of a Discrete Random


Variable
Compute the mean of the following probability
distribution which represents the number of DVDs
a person rents from a video store during a single
visit.

Mean=0*0.06+1*0.58+2
*0.22+3* 0.1+4
*0.03+5*0.01
= 1.49

EXAMPLE

Variance and Std

Compute the variance and standard deviation of


the following probability distribution which
represents the number of DVDs a person rents
from a video store during a single visit.

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:

The number of ships to arrive at a harbor on any given day is a


random variable represented by x. The probability distribution
for x is:

x
P(x
)

10
.4

11
.2

12
.2

13
.1

14
.1

Find the probability that on a given day:


a.

exactly 14 ships arrive

b.

At least 12 ships arrive

p(x 12)= (.2 + .1 +.1) = .4

c.

At most 11 ships arrive

p(x11)= (.4 +.2) = .6

p(x=14)= .1

Practice Problem:

You are lecturing to a group of 1000 students. You


ask them to each randomly pick an integer between 1
and 10. Assuming, their picks are truly random:
Whats your best guess for how many students picked the
number 9?

Since p(x=9) = 1/10, wed expect about 1/10th


of the 1000 students to pick 9. 100 students.

What percentage of the students would you expect picked


a number less than or equal to 6?

Since p(x 6) = 1/10 + 1/10 + 1/10 + 1/10 +


1/10 + 1/10 =.6 60%22

Important discrete distributions


Binomial
Yes/no outcomes (dead/alive,
treated/untreated, smoker/non-smoker,
sick/well, etc.)

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

Expected value, formally


Discrete case:

E( X )

x p(x )
i

all x

Continuous case:

E( X )

xi p(xi )dx

all x

Empirical Mean is a special case of


Expected Value
Sample mean, for a sample of n subjects: =
n

x
i 1

i 1

1
xi ( )
n

The probability (frequency) of each person


in the sample is 1/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)

(1.053) 2 (18 / 38) (1 .053) 2 (20 / 38)


(1.053) 2 (18 / 38) (.947) 2 (20 / 38)
.997

.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!

Handy calculation formula!


Handy calculation formula (if you ever need to calculate by hand!):

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

Criteria for a Binomial Probability Experiment


An experiment is said to be a binomial experiment
provided
1. The experiment is performed a fixed number of
times. Each repetition of the experiment is called a
trial.
2. The trials are independent. This means the
outcome of one trial will not affect the outcome of the
other trials.
3. For each trial, there are two mutually exclusive
outcomes, success or failure.
4. The probability of success is fixed for each trial of
the experiment.

Notation Used in the


Binomial Probability Distribution
There are n independent trials of the experiment
Let p denote the probability of success so that
1 p is the probability of failure.
Let x denote the number of successes in n
independent trials of the experiment. So, 0 < x < n.

Binomial Probability Distribution

A fixed number of observations (trials), n

A binary random variable

e.g., 15 tosses of a coin; 20 patients; 1000 people


surveyed
e.g., head or tail in each toss of a coin; defective or not
defective light bulb
Generally called success and failure
Probability of success is p, probability of failure is 1 p

Constant probability for each observation

e.g., Probability of getting a tail is the same each time


we toss the coin

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%

Introduction to the Poisson Distribution

Poisson distribution is for countsif events


happen at a constant rate over time, the Poisson
distribution gives the probability of X number of
events occurring in time T.

Poisson Mean and Variance


Mean

Variance and Standard


Deviation
2

For a Poisson
random variable,
the variance and
mean are the
same!


where = expected number of hits in a given
time period

Poisson Distribution, example


The Poisson distribution models counts, such as the number of new cases
of SARS that occur in women in New England next month.
The distribution tells you the probability of all possible numbers of new
cases, from 0 to infinity.
If X= # of new cases next month and X ~ Poisson (), then the probability
that X=k (a particular count) is:

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:

Poisson Probability table


X
0
1

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

Example: Poisson distribution


Suppose that a rare disease has an incidence of 1 in 1000 personyears. Assuming that members of the population are affected
independently, find the probability of k cases in a population of
10,000 (followed over 1 year) for k=0,1,2.
The expected value (mean) = = .001*10,000 = 10
10 new cases expected in this population per year
(10) 0 e (10 )
P( X 0)
.0000454
0!
(10)1 e (10 )
P( X 1)
.000454
1!
(10) 2 e (10 )
P ( X 2)
.00227
2!

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)

( 2 * 1.5) 0 e 2 (1.5) (3) 0 e 3


P ( X 0)
e 3 .05
0!
0!
P(X1)=1 .05 = 95% chance
1b. How many phone calls do you expect to get during the movie?
E(X) = t = 2(1.5) = 3

The Poisson probability distribution function


can be used to approximate binomial
probabilities provided the number of trials
n > 100 and np < 10. In other words, the
number of independent trials of the binomial
experiment should be large and the
probability of success should be small.

Please forward your query


To: sjain@amity.edu