Statistics for

Business and Economics

Chapter 4

Probability

Chap 4-1
 Chapter Goals
After completing this chapter, you should be
able to:
 Explain basic probability concepts and definitions

 Use a Venn diagram or tree diagram to illustrate

simple probabilities
 Apply common rules of probability

 Compute conditional probabilities

 Determine whether events are statistically

independent
 Use Bayes’ Theorem for conditional probabilities

Chap 4-2
 Important Terms

 Random Experiment – a process leading to an

uncertain outcome
 Basic Outcome – a possible outcome of a
random experiment
 Sample Space – the collection of all possible
outcomes of a random experiment
 Event – any subset of basic outcomes from the
sample space

Chap 4-3
 Important Terms
(continued)

 Intersection of Events – If A and B are two

events in a sample space S, then the
intersection, A ∩ B, is the set of all outcomes in
S that belong to both A and B

A AB B

Chap 4-4
 Important Terms
(continued)

 A and B are Mutually Exclusive Events if they

have no basic outcomes in common
 i.e., the set A ∩ B is empty

A B

Chap 4-5
 Important Terms
(continued)

 Union of Events – If A and B are two events in a

sample space S, then the union, A U B, is the
set of all outcomes in S that belong to either
A or B
S The entire shaded
area represents
A B AUB

Chap 4-6
 Important Terms
(continued)

 Events E1, E2, … Ek are Collectively Exhaustive

events if E1 U E2 U . . . U Ek = S
 i.e., the events completely cover the sample space

 The Complement of an event A is the set of all

basic outcomes in the sample space that do not
belong to A. The complement is denoted A
S
A
A

Chap 4-7
 Examples
Let the Sample Space be the collection of all
possible outcomes of rolling one die:

S = [1, 2, 3, 4, 5, 6]

Let A be the event “Number rolled is even”

Let B be the event “Number rolled is at least 4”
Then
A = [2, 4, 6] and B = [4, 5, 6]
Chap 4-8
 Examples
(continued)

S = [1, 2, 3, 4, 5, 6] A = [2, 4, 6] B = [4, 5, 6]

Complements:
A  [1, 3, 5] B  [1, 2, 3]

Intersections:
A  B  [4, 6] A  B  [5]
Unions:
A  B  [2, 4, 5, 6]
A  A  [1, 2, 3, 4, 5, 6]  S
Chap 4-9
 Examples
(continued)

S = [1, 2, 3, 4, 5, 6] A = [2, 4, 6] B = [4, 5, 6]

 Mutually exclusive:
 A and B are not mutually exclusive
 The outcomes 4 and 6 are common to both

 Collectively exhaustive:
 A and B are not collectively exhaustive
 A U B does not contain 1 or 3

Chap 4-10
 Probability

 Probability – the chance that 1 Certain

an uncertain event will occur
(always between 0 and 1)

0 ≤ P(A) ≤ 1 For any event A .5

0 Impossible

Chap 4-11
 Assessing Probability
 There are three approaches to assessing the
probability of an uncertain event:

1. classical probability
NA number of outcomes that satisfy the event
probability of event A  
N total number of outcomes in the sample space

 Assumes all outcomes in the sample space are equally likely to

occur

Chap 4-12
 Counting the Possible Outcomes

 Use the Combinations formula to determine the

number of combinations of n things taken k at a
time

n!
C n
k
k! (n  k)!
 where
 n! = n(n-1)(n-2)…(1)
 0! = 1 by definition

Chap 4-13
 Assessing Probability
Three approaches (continued)
2. relative frequency probability
nA number of events in the population that satisfy event A
probability of event A  
n total number of events in the population
 the limit of the proportion of times that an event A occurs in a large number of
trials, n

3. subjective probability
an individual opinion or belief about the probability of occurrence

Chap 4-14
 Probability Postulates
1. If A is any event in the sample space S, then
0  P(A)  1
2. Let A be an event in S, and let Oi denote the basic outcomes.
Then
P(A)   P(Oi )
A

(the notation means that the summation is over all the basic outcomes in A)

3. P(S) = 1

Chap 4-15
 Probability Rules

 The Complement rule:

P(A)  1 P(A) i.e., P(A)  P(A)  1

 The Addition rule:

 The probability of the union of two events is

P(A  B)  P(A)  P(B)  P(A  B)

Chap 4-16
 Addition Rule Example

Consider a standard deck of 52 cards, with four suits:

♥♣♦♠
Let event A = card is an Ace
Let event B = card is from a red suit

Chap 4-17
 Addition Rule Example
(continued)

P(Red U Ace) = P(Red) + P(Ace) - P(Red ∩ Ace)

= 26/52 + 4/52 - 2/52 = 28/52

Don’t count
the two red
Color aces twice!
Type Red Black Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52

Chap 4-18
 Conditional Probability
 A conditional probability is the probability of one
event, given that another event has occurred:

P(A  B) The conditional

P(A | B)  probability of A given
P(B) that B has occurred

P(A  B) The conditional

P(B | A)  probability of B given
P(A) that A has occurred

Chap 4-19
 Conditional Probability Example

 Of the cars on a used car lot, 70% have air

conditioning (AC) and 40% have a CD player
(CD). 20% of the cars have both.

 What is the probability that a car has a CD

player, given that it has AC ?

i.e., we want to find P(CD | AC)

Chap 4-20
 Conditional Probability Example
(continued)
 Of the cars on a used car lot, 70% have air conditioning
(AC) and 40% have a CD player (CD).
20% of the cars have both.
CD No CD Total
AC .2 .5 .7
No AC .2 .1 .3
Total .4 .6 1.0

P(CD  AC) .2
P(CD | AC)    .2857
P(AC) .7
Chap 4-21
 Conditional Probability Example
(continued)
 Given AC, we only consider the top row (70% of the cars). Of these,
20% have a CD player. 20% of 70% is 28.57%.

CD No CD Total
AC .2 .5 .7
No AC .2 .1 .3
Total .4 .6 1.0

P(CD  AC) .2
P(CD | AC)    .2857
P(AC) .7

Chap 4-22
 Multiplication Rule

 Multiplication rule for two events A and B:

P(A  B)  P(A | B) P(B)

 also

P(A  B)  P(B | A) P(A)

Chap 4-23
 Multiplication Rule Example
P(Red ∩ Ace) = P(Red| Ace)P(Ace)
 2  4  2
    
 4  52  52
number of cards that are red and ace 2
 
total number of cards 52

Color
Type Red Black Total
Ace 2 2 4
Non-Ace 24 24 48
Total 26 26 52
Chap 4-24
 Statistical Independence
 Two events are statistically independent
if and only if:
P(A  B)  P(A) P(B)
 Events A and B are independent when the probability of one
event is not affected by the other event
 If A and B are independent, then

P(A | B)  P(A) if P(B)>0

P(B | A)  P(B) if P(A)>0

Chap 4-25
 Statistical Independence Example
 Of the cars on a used car lot, 70% have air conditioning
(AC) and 40% have a CD player (CD).
20% of the cars have both.
CD No CD Total
AC .2 .5 .7
No AC .2 .1 .3
Total .4 .6 1.0

 Are the events AC and CD statistically independent?

Chap 4-26
 Odds

 The odds in favor of a particular event are

given by the ratio of the probability of the
event divided by the probability of its
complement
 The odds in favor of A are

P(A) P(A)
odds  
1- P(A) P(A)

Chap 4-27
 Odds: Example
 Calculate the probability of winning if the odds
of winning are 3 to 1:
3 P(A)
odds  
1 1- P(A)

 Now multiply both sides by 1 – P(A) and solve for P(A):

3 x (1- P(A)) = P(A)

3 – 3P(A) = P(A)
3 = 4P(A)
P(A) = 0.75
Chap 4-28
 Bayes’ Theorem
P(A | E i )P(E i )
P(E i | A) 
P(A)
P(A | E i )P(E i )

P(A | E 1 )P(E 1 )  P(A | E 2 )P(E 2 )    P(A | E k )P(E k )

 where:
Ei = ith event of k mutually exclusive and collectively
exhaustive events
A = new event that might impact P(Ei)

Chap 4-29
 Bayes’ Theorem Example

 A drilling company has estimated a 40%

chance of striking oil for their new well.
 A detailed test has been scheduled for more
information. Historically, 60% of successful
wells have had detailed tests, and 20% of
unsuccessful wells have had detailed tests.
 Given that this well has been scheduled for a
detailed test, what is the probability
that the well will be successful?

Chap 4-30
 Bayes’ Theorem Example
(continued)

 Let S = successful well

U = unsuccessful well
 P(S) = .4 , P(U) = .6 (prior probabilities)
 Define the detailed test event as D
 Conditional probabilities:
P(D|S) = .6 P(D|U) = .2
 Goal is to find P(S|D)

Chap 4-31
 Bayes’ Theorem Example
(continued)

Apply Bayes’ Theorem:

P(D | S)P(S)
P(S | D) 
P(D | S)P(S)  P(D | U)P(U)
(.6)(.4)

(.6)(.4)  (.2)(.6)
.24
  .667
.24  .12
So the revised probability of success (from the original estimate of .4),
given that this well has been scheduled for a detailed test, is .667

Chap 4-32
 Chapter Summary
 Defined basic probability concepts
 Sample spaces and events, intersection and union of events,
mutually exclusive and collectively exhaustive events,
complements
 Examined basic probability rules
 Complement rule, addition rule, multiplication rule
 Defined conditional, joint, and marginal probabilities
 Reviewed odds and the overinvolvement ratio
 Defined statistical independence
 Discussed Bayes’ theorem

Chap 4-33