Quantitative

methods for
business
Lecture 2.2: Review Probability
Concepts and Applications
Objectives:

• Basic foundations of probability analysis

• Statistically dependent and independent events
• Bayes’ theorem to establish posterior probabilities
• Describe and provide examples of both discrete and
continuous random variables
• Explain the difference between discrete and continuous
probability distributions
• Calculate expected values and variances and use the
normal table
 Probability

A probability is a numerical statement about the chance

that an even will occur.
• The probability, P, of any event or state of nature occurring is
greater than or equal to 0 and less than or equal to 1.

• The sum of the simple probabilities for all possible outcomes of an

activities must equal 1.
Types of Probability

• Objective probability: based on logical observation

Number of occurrences of the event

P (event) =
Total number of trials or outcomes

Ex: The probability of tossing a fair coin once and getting a

head

• Subjective probability: based on personal experiences

and judgement.

Ex: What is the probability that the price of gasoline will

be more than $0 in 2020?
 Diversey Paint Example
What are the probability that the sales are 3 gallons of
paint on any given day?

Whether it is a subjective or objective probability?

QUANTITY
DEMANDED NUMBER OF DAYS PROBABILITY
0 40 0.20 (= 40/200)
1 80 0.40 (= 80/200)
2 50 0.25 (= 50/200)
3 20 0.10 (= 20/200)
4 10 0.05 (= 10/200)
Total 200 Total 1.00 (= 200/200)
Mutually exclusive and Collectively exhaustive
event
• Events are mutually exclusive if only one of the events can occur
on any one trial.
Ex: Tossing a coin will result in either a head or a tail. Rolling a die will result in
only one of six possible outcomes.
• Events are collectively exhaustive if the list of outcome includes
every possible outcome.

Example: Rolling a Die

Outcome of roll Probability
1 1/6
2 1/6
3 1/6
4 1/6
5 1/6
6 1/6
Mutually exclusive and Collectively exhaustive event
MUTUALLY COLLECTIVELY
DRAWS EXCLUSIVE EXHAUSTIVE
1. Draws a spade and a club
2. Draw a face card and a
number card
3. Draw an ace and a 3
4. Draw a club and a nonclub
5. Draw a 5 and a diamond
6. Draw a red card and a
diamond
Adding mutually exclusive events
• Adding mutually exclusive events

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

P (A) P (B)
EX: P (spade or club) = P (spade) + P (club)
= 13/52 + 13/52
= 26/52 = 1/2 = 0.50 = 50%
• Adding not mutually exclusive events.

P(A or B) = P(A) +P(B) – P(A and B)

EX: P(five or diamond) = P(five) + P(diamond) – P(five and diamond)

= 4/52 + 13/52 – 1/52
P (A and B)
= 16/52 = 4/13
P (A) P (B)
 Independent events / Dependent events
• Independent events: the occurrence of one event has no effect on
the probability of occurrence of the second event.
• Dependent events: The occurrence of one event affects the
probability of occurrence of some other event.

Which Sets of Events Are Independent?

1. (a) Your education
Dependent events
(b) Your income level

2. (a) Draw a jack of hearts from a full 52-card deck Independent

(b) Draw a jack of clubs from a full 52-card deck events

3. (a) Chicago Cubs win the National League pennant Dependent

(b) Chicago Cubs win the World Series events

4. (a) Snow in Santiago, Chile

(b) Rain in Tel Aviv, Israel Independent events
Statistically Independent Events
Three Types of Probabilities
Marginal (or simple) probability is just the probability of an
event occurring
P (A)
 Joint probability is the probability of two or more
events occurring and is the product of their marginal
probabilities for independent events
P (AB) = P (A) x P (B)
 Conditional probability is the probability of event B given
that event A has occurred
P (B | A) = P(B)
Or the probability of event A given that event B has
occurred
P (A | B) = P(A)
Statistically Independent Events
A bucket contains 3 black balls and 7 green balls
 We draw a ball from the bucket, put it back, and
draw a second ball
1. A black ball drawn on first draw
P (B) = 0.30 (a marginal probability)
2. Two green balls drawn
P (GG) = P (G) x P (G) = 0.7 x 0.7 = 0.49
(a joint probability for two independent events)
3. A black ball drawn on second draw if the first draw is green
P (B | G) = P (B) = 0.30
(a conditional probability but equal to the marginal
because the two draws are independent events)
4. A green ball is drawn on the second if the first draw was green
P (G | G) = P (G) = 0.70
(a conditional probability as in event 3)
When events are dependent

The marginal probability of an event occurring is computed the same

P (A)

Calculating conditional probabilities is slightly more

complicated. The probability of event A given that event B has
occurred is
P (AB)
P (A | B) = P (B)

The formula for the joint probability of two events is

P (AB) = P (A | B) P (B)
When events are dependent
EXAMPLE
Assume that we have an urn containing 10 balls of
the following descriptions
 4 are white (W) and lettered (L)
 2 are white (W) and numbered (N)
 3 are yellow (Y) and lettered (L)
 1 is yellow (Y) and numbered (N)

What is the conditional probability that the ball drawn

is lettered, given that it is yellow?
When events are dependent

The conditional probability that the ball drawn

is lettered, given that it is yellow, is

P (YL) 0.3
P (L | Y) = = = 0.75
P (Y) 0.4

Verify P (YL) using the joint probability formula

P (YL) = P (L | Y) x P (Y) = (0.75)(0.4) = 0.3

When events are dependent
If the stock market reaches 12,500 point by January,
there is a 70% probability that Tubeless Electronics
will go up
 There is a 40% chance the stock market will
reach 12,500
 Let M represent the event of the stock market
reaching 12,500 and let T be the event that
Tubeless goes up in value
What is the joint probability that the stock market
reaching 12,500 and Tubeless goes up in value?

P (MT) = P (T | M) x P (M) = (0.70)(0.40) = 0.28

Bayes’ Theorem

Bayes’ theorem is used to incorporate additional information

and help create posterior probabilities.

Prior
Probabilities

Bayes’ Posterior
Process Probabilities

New
Information
Bayes’ Theorem
Posterior Probabilities
A cup contains two dice identical in appearance but one is fair
(unbiased), the other is loaded (biased)
• The probability of rolling a 3 on the fair die is 1/6 or 0.166
• The probability of tossing the same number on the loaded die is
0.60
• We select one by chance,
toss it, and get a result of a 3
• What is the probability that
the die rolled was fair?
• What is the probability that
the loaded die was rolled?
Bayes’ Theorem

Bayes Calculations
Given event B has occurred
STATE OF P (B | STATE PRIOR JOINT POSTERIOR
NATURE OF NATURE) PROBABILITY PROBABILITY PROBABILITY

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

A’ P(B | A’) x P(A’) = P(B and A’) P(B and A’)/P(B) = P(A’|B)
P(B)

Given a 3 was rolled

STATE OF P (B | STATE PRIOR JOINT POSTERIOR
NATURE OF NATURE) PROBABILITY PROBABILITY PROBABILITY

Fair die 0.166 x 0.5 = 0.083 0.083 / 0.383 = 0.22

Loaded die 0.600 x 0.5 = 0.300 0.300 / 0.383 = 0.78
P(3) = 0.383
Bayes’ Theorem
A second probability revision
Toss the die a second time. Again, we roll a 3. What are the
further revised (posterior) probability?

Given a 3 was rolled a second time

STATE OF P (B | STATE PRIOR JOINT POSTERIOR
NATURE OF NATURE) PROBABILITY PROBABILITY PROBABILITY

Fair die 0.166x0.166 x 0.5 = 0.013 0.013 / 0.193 = 0.067

Loaded die 0.6x0.6 x 0.5 = 0.18 0.18 / 0.193 = 0.933
P(3,3) = 0.193
Random Variables

A random variable assigns a real number to every

possible outcome or event in an experiment
X = number of smartphones sold during the day

• Discrete random variables can assume only a

finite or limited set of values
• Continuous random variables can assume any
one of an infinite set of values
Random Variables - Numbers
RANDOM RANGE OF
EXPERIMENT OUTCOME RANDOM
VARIABLES
VARIABLES
Discrete Stock 50 Number of Christmas X 0, 1, 2,…, 50
Christmas trees trees sold
Inspect 600 Number of acceptable Y 0, 1, 2,…, 600
Discrete items items

Discrete Send out 5,000 Number of people Z 0, 1, 2,…, 5,000

sales letters responding to the
letters
Build an Percent of building R 0 ≤ R ≤ 100
Continuous apartment completed after 4
building months
Test the lifetime Length of time the S 0 ≤ S ≤ 80,000
Continuous of a lightbulb bulb lasts up to 80,000
(minutes) minutes
Random Variables – Not Numbers
RANGE OF
RANDOM
EXPERIMENT OUTCOME RANDOM
VARIABLES
VARIABLES
Students Strongly agree (SA) 5 if SA 1, 2, 3, 4, 5
Discrete respond to a Agree (A) 4 if A..
questionnaire Neutral (N) X= 3 if N..
Disagree (D) 2 if D..
Strongly disagree (SD) 1 if SD

One machine Defective Y= 0 if defective 0, 1

Discrete is inspected Not defective 1 if not defective

Consumers Good 3 if good…. 1, 2, 3

respond to Average Z= 2 if average
Discrete how they like Poor 1 if poor…..
a product
Discrete Vs Continuous probability distribution

• The probability distribution of a • A continuous random variable any

discrete random variable X is a list of single outcome has probability zero
each possible value of X together with of occurring. The probability density
the probability that X takes that value function gives the probability that
in one trial of the experiment. any value in a continuous set of
• F(x) must be between 0 and 1. values might occur. 
• Sum of f(x) =1

Normal distribution
Binomial distribution
Exponential distribution
Poisson distribution
The Binomial distribution a frequency distribution of the
possible number of successful
outcomes in a given number of
• n = number of trials
trials in each of which there is the
• p = the probability of a success on any singer trial same probability of success.
• r = the number of success

The binomial formula:

We want to find the probability of 4 heads in 5 tosses of a

coin, we have:
n=5, r=4, p=0.5
Thus

Or about 16%
 The Binomial distribution
Example
MSA Electronics is experimenting with the manufacture of a
new transistor
 Every hour a sample of 5 transistors is taken
 The probability of one transistor being defective is 0.15
What is the probability of finding 3, 4, or 5 defective?

P
n r 0.05 0.10 0.15
5 0 0.7738 0.5905 0.4437
1 0.2036 0.3281 0.3915
2 0.0214 0.0729 0.1382
3 0.0011 0.0081 0.0244
4 0.0000 0.0005 0.0022
5 0.0000 0.0000 0.0001
The Binomial distribution

It is easy to find the expected value (or mean) and

variance of a binomial distribution

Expected value (mean) = np

Variance = np(1 – p)

For the MSA example

 The Poisson Distribution
• The Poisson distribution is a discrete distribution
that is often used in queuing models to describe
arrival rates over time

where
P(X) = probability of exactly X arrivals or occurrences
 = average number of arrivals per unit of time
(the mean arrival rate)
e = 2.718, the base of natural logarithms
X = specific value (0, 1, 2, 3, and so on) of the random
variable
 The Poisson Distribution
• The mean and variance of the distribution are both 

Expected value = 
Variance = 
0.3 –

0.2 –
P(X)

0.1 –

0 –| | | | | | | | | |
0 1 2 3 4 5 6 7 8
X
 The Normal Distribution

The normal distribution is the most popular and

useful continuous probability distribution
• The formula for the probability density function is
rather complex

• The normal distribution is symmetrical, with the midpoint representing the

mean
• Shifting the mean does not change the shape of the distribution
• Values on the X axis are measured in the number of standard deviations away
from the mean
• As the standard deviation becomes larger, the curve flattens
• As the standard deviation becomes smaller, the curve becomes steeper
 The Normal Distribution
If IQs in the United States were normally distributed with µ = 100
and  = 15, then
16% 68% 16%

1. 68% of the population

would have IQs between
–1 +1
85 and 115 points (±1) a µ b
2. 95.4% of the people have
IQs between 70 and 130
(±2) 2.3% 95.4% 2.3%
3. 99.7% of the population
have IQs in the range from
55 to 145 points (±3) a
–2
µ
+2
b
4. Only 16% of the people
have IQs greater than 115
points (from the first graph,
the area to the right of 0.15% 99.7% 0.15%
+1)
–3 +3
a µ b
Using the Standard Normal Table
Step 1
Convert the normal distribution into a standard
normal distribution
 A standard normal distribution has a mean of 0
and a standard deviation of 1
 The new standard random variable is Z

where
X = value of the random variable we want to measure
µ = mean of the distribution
 = standard deviation of the distribution
Z = number of standard deviations from X to the mean, µ
Using the Standard Normal Table
For example, µ = 100,  = 15, and we want to find
the probability that X is less than 130

µ = 100
P(X < 130)  = 15

| | | | | | |
X = IQ
55 70 85 100 115 130 145

| | | | | | |
–3 –2 –1 0 1 2 3
Using the Standard Normal Table
Step 2
Look up the probability from a table of normal curve
areas
 Use Appendix A or Table 2.9 (portion below)
 The column on the left has Z values
 The row at the top has second decimal places
for the Z values
AREA UNDER THE NORMAL CURVE
Z 0.00 0.01 0.02 0.03
1.8 0.96407 0.96485 0.96562 0.96638 P(X < 130)
1.9
2.0
0.97128
0.97725
0.97193
0.97784
0.97257
0.97831
0.97320
0.97882
= (Z < 2.00)
2.1 0.98214 0.98257 0.98300 0.98341 = 97.7%
2.2 0.98610 0.98645 0.98679 0.98713
 Haynes Construction Company

Haynes builds apartment buildings

 Total construction time follows a normal distribution
 For triplexes, µ = 100 days and  = 20 days
 Contract calls for completion in 125 days
 Late completion will incur a severe penalty fee
 What is the probability of completing in 125 days?
 Completion in 75 days or less will earn a bonus of $5,000.
What is the probability of getting the bonus?
 The Exponential Distribution

• The exponential distribution (also called the

negative exponential distribution) is a continuous
distribution often used in queuing models to
describe the time required to service a customer

where
X = random variable (service times)
µ = average number of units the service facility can
handle in a specific period of time
e = 2.718 (the base of natural logarithms)
The Exponential Distribution

f(X)

X
In-class practice 1
2-18 Last year, at Northern Manufacturing Company has 1000 employees, 200
people had colds during the year. One hundred fifty-five people who did no
exercising had colds, and the remainder of the people with colds were involved
in a weekly exercise program. Half of the 1,000 employees were involved in
some type of exercise.
(a) What is the probability that an employee will have a cold next year?
(b) Given that an employee is involved in an exercise program, what is the
probability that he or she will get a cold next year?
(c) What is the probability that an employee who is not involved in an exercise
program will get a cold next year?
(d) Are exercising and getting a cold independent events? Explain your answer.
In-class practice 2

2-33 Gary Schwartz is the top salesman for his company. Records
indicate that he makes a sale on 70% of his sales calls. If he calls
on four potential clients, what is the probability that he makes
exactly 3 sales? What is the probability that he makes exactly 4
sales?
In-class practice 3
2-42 A new integrated computer system is to be installed worldwide for a major
corporation. Bids on this project are being solicited, and the contract will be
awarded to one of the bidders. As a part of the proposal for this project, bidders
must specify how long the project will take. There will be a significant penalty for
finishing late. One potential contractor determines that the average time to
complete a project of this type is 40 weeks with a standard deviation of 5 weeks.
The time required to complete this project is assumed to be normally distributed.

(a) If the due date of this project is set at 40 weeks, what is the probability that the
contractor will have to pay a penalty (i.e., the project will not be finished on
schedule)?

(b) If the due date of this project is set at 43 weeks, what is the probability that the
contractor will have to pay a penalty (i.e., the project will not be finished on
schedule)?

(c) If the bidder wishes to set the due date in the proposal so that there is only a 5%
chance of being late (and consequently only a 5% chance of having to pay a
penalty), what due date should be set?
ASSIGNMENTS
Text book: “Quantitative Analysis for Management, 11th edition”, Barry Render et. al.,
McGraw Hill, 2012.

Homework: randomly ask someone solve in class.

1. Assignments (Chapter 2): 2-14, 2-16, 2-18, 2-20, 2-32,
2-33, 2-37, 2-42, and 2-47.
2. One-page summary of the lecture.