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Chapter 5
Random Experiments

Sample Space

• A random experiment is an observational process whose results cannot be

known in advance.

• The set of all outcomes (S) is the sample space for the experiment.

• A sample space with a countable number of outcomes is discrete.

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Chapter 5
Random Experiments

Sample Space
• For a single roll of a die, the sample space is:

• When two dice are rolled, the sample space is pairs:

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Chapter 5
Probability

Definitions

• The probability of an event is a number that measures the relative

likelihood that the event will occur.
• The probability of event A [denoted P(A)] must lie within the
interval from 0 to 1:
0 ≤ P(A) ≤ 1

If P(A) = 0, then the event If P(A) = 1, then the event

cannot occur. is certain to occur.

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Chapter 5
Probability

Empirical Approach

• Use the empirical or relative frequency approach to assign probabilities by

counting the frequency (fi) of observed outcomes defined on the
experimental sample space.

• For example, to estimate the default rate on student loans:

P(a student defaults) = f /n = number of defaults

number of loans

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Chapter 5
Probability

Law of Large Numbers

The law of large numbers says that as the number of trials increases, any
empirical probability approaches its theoretical limit.

• Flip a coin 50 times. We would expect the proportion of heads to be near

.50.

• However, in a small finite sample, any ratio can be obtained (e.g., 1/3,
7/13, 10/22, 28/50, etc.).

• A large n may be needed to get close to .50.

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Chapter 5
Probability
As the number of trials increases, any empirical
Law of Large Numbers probability approaches its theoretical limit.

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Chapter 5
Probability

Classical Approach
• For example, the two-dice experiment has 36 equally likely simple events.
The P(that the sum of the dots on the two faces equals 7) is

• The probability is obtained

a priori using the classical
approach as shown in this
Venn diagram for 2 dice:

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Chapter 5
Probability

Subjective Approach
• A subjective probability reflects someone’s informed judgment about the
likelihood of an event.

• Used when there is no repeatable random experiment.

For example:
• What is the probability that a new truck
product program will show a return on
investment of at least 10 percent?
• What is the probability that the price of Ford’s
stock will rise within the next 30 days?

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Chapter 5
Rules of Probability

Complement of an Event

• The complement of an event A is denoted by

Aʹ and consists of everything in the sample space S except event A.

• Since A and Aʹ together

comprise the entire sample
space,
P(A) + P(Aʹ ) = 1 or P(Aʹ ) = 1 –
P(A)

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Chapter 5
Rules of Probability

Union of Two Events

(Figure 5.5)
• The union of two events consists of all outcomes in the sample space S
that are contained either in event A or in event B or in both (denoted A È
B or “A or B”).

È may be read as “or”

since one or the other
or both events may
occur.

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Chapter 5
Rules of Probability

Intersection of Two Events

• The intersection of two events A and B
(denoted by A Ç B or “A and B”) is the event consisting of all outcomes in
the sample space S that are contained in both event A and event B.

Ç may be read as
“and” since both
events occur. This is a
joint probability.

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Chapter 5
Rules of Probability

General Law of Addition

• The general law of addition states that the probability of the union of two
events A and B is:

P(A È B) = P(A) + P(B) – P(A Ç B)

When you add P(A) A and B So, you have to

and P(B) together, subtract
you count P(A and P(A Ç B) to avoid
B) twice. A B overstating the
probability.

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Chapter 5
Rules of Probability

General Law of Addition

• For a standard deck of cards:

P(Q) = 4/52 (4 queens in a deck; Q = queen)

P(R) = 26/52 (26 red cards in a deck; R = red)
P(Q Ç R) = 2/52 (2 red queens in a deck)
P(Q È R) = P(Q) + P(R) – P(Q Ç R)
Q and R = 2/52
= 4/52 + 26/52 – 2/52
Q R
= 28/52 = .5385 or 53.85%
4/52 26/52

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Chapter 5
Rules of Probability

Mutually Exclusive Events

• Events A and B are mutually exclusive (or disjoint) if their intersection is
the null set (f) which contains no elements.
If A Ç B = f, then P(A Ç B) = 0

Special Law of Addition

• In the case of mutually
exclusive events, the addition
law reduces to:

P(A È B) = P(A) + P(B)

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Chapter 5
Rules of Probability

Dichotomous Events
• Events are collectively exhaustive if their union is the entire
sample space S.

• Two mutually exclusive, collectively exhaustive events are

dichotomous (or binary) events.

For example, a car repair is

either covered by the warranty
(A) or not (A’).

Note: This concept can be

extended to more than two
No events. See the next slide
Warranty
Warranty
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Chapter 5
Rules of Probability

Polytomous Events
There can be more than two mutually exclusive, collectively exhaustive
events, as illustrated below. For example, a Walmart customer can pay by
credit card (A), debit card (B), cash (C), or
check (D).

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Chapter 5
Rules of Probability

Conditional Probability
• The probability of event A given that event B has occurred.

• Denoted P(A | B).

The vertical line “ | ” is read as “given.”

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Chapter 5
Rules of Probability

Conditional Probability
• Consider the logic of this formula by looking at the Venn diagram.

The sample space is restricted to B,

an event that has occurred.

A Ç B is the part of B that is also in

A.

The ratio of the relative size of A Ç B

to B is P(A | B).

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Chapter 5
Rules of Probability

Example: High School Dropouts

• Of the population aged 16–21 and not in college:

Unemployed 13.5%
High school dropouts 29.05%

Unemployed high school dropouts 5.32%

• What is the conditional probability that a member of this population is

unemployed, given that the person is a high school dropout?

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Chapter 5
Rules of Probability

Example: High School Dropouts

• Of the population aged 16–21 and not in college:

Unemployed 13.5%
High school dropouts 29.05%

Unemployed high school dropouts 5.32%

• What is the conditional probability that a member of this population is

unemployed, given that the person is a high school dropout?

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Chapter 5
Independent Events

• Event A is independent of event B if the conditional probability P(A | B)

is the same as the marginal probability P(A).

• P(U | D) = .1831 > P(U) = .1350, so U and D are not independent. That is,
they are dependent.

• Another way to check for independence: Multiplication Law

If P(A Ç B) = P(A)P(B) then event A is independent of event B since

P( A Ç B) P( A) ´ P( B)
P( A | B) = = = P( A)
P( B) P( B)

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Chapter 5
Independent Events

Multiplication Law (for Independent Events)

• The probability of n independent events occurring simultaneously is:

P(A1 Ç A2 Ç ... Ç An) = P(A1) P(A2) ... P(An)

if the events are independent

• To illustrate system reliability, suppose a website has 2 independent file

servers. Each server has 99% reliability. What is the total system
reliability? Let

F1 be the event that server 1 fails

F2 be the event that server 2 fails

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Chapter 5
Independent Events

Multiplication Law (for Independent Events)

• Applying the rule of independence:

P(F1 Ç F2 ) = P(F1) P(F2) = (.01)(.01) = .0001

• So, the probability that both servers are down is .0001.

• The probability that one or both servers is “up” is:

1 - .0001 = .9999 or 99.99%

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Chapter 5
Contingency Table

Example: Salary Gains and MBA Tuition

• Consider the following cross-tabulation (contingency) table for n = 67 top-
tier MBA programs:

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Chapter 5
Contingency Table
The marginal probability of a single event is found by dividing a
row or column total by the total sample size.
Example: find the marginal probability of a medium
salary gain (P(S2).

P(S2) = 33/67 = .4925

• About 49% of salary gains at the top-tier schools were between $50,000
and $100,000 (medium gain).

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Chapter 5
Contingency Table

Joint Probabilities
• A joint probability represents the intersection of two events in a cross-
tabulation table.
• Consider the joint event that the school has
low tuition and large salary gains (denoted as P(T1 Ç S3)).

P(T1 Ç S3) = 1/67 = .0149

• There is less than a 2% chance that a top-tier school has both low tuition
and large salary gains.

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Chapter 5
Contingency Table
Conditional Probabilities
• Find the probability that the salary gains are small (S1) given that the MBA
tuition is large (T3).

P(T3 | S1) = 5/32 = .1563

Independence
Conditional Marginal

P(S3 | T1)= 1/16 = .0625 P(S3) = 17/67 = .2537

• (S3) and (T1) are dependent.

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Chapter 5
Tree Diagrams

What is a Tree?
• A tree diagram or decision tree helps you visualize all possible outcomes.

• Start with a contingency table. For example, this table gives expense
ratios by fund type for 21 bond funds and 23 stock funds.
•

• The tree diagram shows all events along with their marginal, conditional,
and joint probabilities.

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Chapter 5
Tree Diagrams
Tree Diagram for Fund Type and Expense Ratios

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Chapter 5
Counting Rules

Fundamental Rule of Counting

• If event A can occur in n1 ways and event B can occur in n2 ways, then
events A and B can occur in n1 x n2 ways.

• In general, m events can occur

n1 x n2 x … x nm ways.

Example: Stockkeeping Labels

• How many unique stockkeeping unit (SKU) labels can a hardware store
create by using two letters (ranging from AA to ZZ) followed by four
numbers (0 through 9)?

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Chapter 5
Counting Rules

Example: Stockkeeping Labels

• For example, AF1078: hex-head 6 cm bolts – box of 12;

RT4855: Lime-A-Way cleaner – 16 ounce LL3319: Rust-Oleum primer –
gray 15 ounce
• There are 26 x 26 x 10 x 10 x 10 x 10 = 6,760,000 unique inventory labels.

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Chapter 5
Counting Rules

Factorials
• The number of ways that n items can be arranged in a particular
order is n factorial.
• n factorial is the product of all integers from 1 to n.

n! = n(n–1)(n–2)...1
• Factorials are useful for counting the possible arrangements of any n
items.
• There are n ways to choose the first, n-1 ways to choose the second, and
so on.
• A home appliance service truck must make 3 stops (A, B, C). In how many
ways could the three stops be arranged?
Answer: 3! = 3 x 2 x 1 = 6 ways
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Chapter 5
Counting Rules

Permutations
• A permutation is an arrangement in a particular order of r randomly
sampled items from a group of n items and is denoted by nPr

• In other words, how many ways can the r items be arranged from n items,
treating each arrangement as different (i.e., XYZ is different from ZYX)?

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Chapter 5
Counting Rules

Combinations
• A combination is an arrangement of r items chosen at random from n
items where the order of the selected items is not important (i.e., XYZ is
the same as ZYX).
• A combination is denoted nCr

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