PROBABILITY THEORY

There are lots of situations where you can't know an outcome for sure. Probability is used in this case, to analyze the different possibilities, and how likely each of them is. Weigh the possible outcomes of a decision by assigning probabilities to payoff values and finding expected values. a. Find the expected payoff for a game of chance. For example, find the expected winnings from a state lottery ticket or a game at a fast-food restaurant. b. Evaluate and compare strategies on the basis of expected values. For example, compare a high-deductible versus a low-deductible automobile insurance policy using various, but reasonable, chances of having a minor or a major accident. Use probabilities to make fair decisions (e.g., drawing by lots, using a random number generator). Analyze decisions and strategies using probability concepts (e.g., product testing, medical testing, pulling a hockey goalie at the end of a game).

THREE VIEWS
1 Subjective View Probability is a measure of the strength of ones expectation that an event will occur. Example: I think there is a 95% likelihood of Exito being a success.

Others may have a different view!

THREE VIEWS
2 Logical (Mathematical) View The probability of an event, say A, occurring is given by the number of events favouring A (nA) divided by the total number of equally likely events (nS) = nA/nS. Example: The probability of picking the Ace of Spades from a pack of shuffled cards is 1/52.

This is independent of people!

THREE VIEWS
3 Empirical (Experimentation) View The probability of an event A occurring, p(A), is a value approached by the ratio nA/n as the total number of observations, n, approaches infinity. Example: The probability of occurrence of a plane crash from past data.

The value may be neither subjective nor logical.

EXPERIMENTS AND EVENTS

Experiment: A procedure for carrying out a trial in order to observe an event or outcome. Event: An observable happening or outcome.

SIMPLE EVENT & COMPOUND EVENT

Simple events Event E1 observe a 1 Event E2 observe a 2 Event E3 observe a 3 Event E4 observe a 4 Event E5 observe a 5 Event E6 observe a 6 Compound events Event A observe an odd number Event B observe an even number Event C observe a number < 3

A compound event can be decomposed into simpler events.

EULER DIAGRAMS

SAMPLE POINT Representation of a simple event

SAMPLE SPACE Set of all sample points

EXAMPLES EULER DIAGRAMS

Simple events Event E1 observe a 1 Event E2 observe a 2 Event E3 observe a 3 Event E4 observe a 4 Event E5 observe a 5 Event E6 observe a 6 Compound events Event A observe an odd number Event B observe an even number Event C observe a number < 3

1 Plot the sample space and events A, B, C. 2 Compute the probabilities of events A, B, C.

SUMMARY OF PROBABILITIES
Rule 1: Probability assigned to an event lies between 0 and 1. 0 p(Ei) 1 Rule 2: Sum of probabilities over the sample space = 1. p(Ei) = 1

Rule 3: Probability of a sure event = 1. p(S) = 1

COMBINED EVENTS
p(A or B) = probability of occurrence of Event A or probability of occurrence of Event B or probability of occurrence of Events A & B Union of two events: use addition rule

p(A and B) = probability of occurrence of Event A and probability of occurrence of Event B Intersection of two events: use multiplication rule

ADDITION RULE OF PROBABILITY

The probability of the union of two events A and B p(A or B) = p(A) + p(B) p(A and B)

EXAMPLE: Rolling a die Event A: Occurrence of an even number (E2, E4, E6) Event B: Occurrence of a number < 5 (E1, E2, E3, E4) Compute p(A or B) after drawing the Euler diagram.

ADDITION RULE OF PROBABILITY

EXAMPLE: Rolling a die Event A: Occurrence of an even number (E2, E4, E6) Event B: Occurrence of a number < 5 (E1, E2, E3, E4) Compute p(A or B) after drawing the table of events.

Event A Event B Events A and B

Not Event A Event B and Not A

Not Event B Event A and Not B

Not A and Not B

COMPLEMENT RULE OF PROBABILITY

The complement of A is Not A p(Not A) = 1 - p(A)

EXAMPLE: Rolling a die Event A: Occurrence of an even number (E2, E4, E6) Event B: Occurrence of a number < 5 (E1, E2, E3, E4) Compute p{Not (A or B)} from the Euler diagram; from the table of events.

EVENTS THAT ARE MUTUALLY EXCLUSIVE

Two events that have no sample points in common are said to be mutually exclusive. Example: Draw the Euler diagram for rolling a die with Event A = occurrence of an odd number Event B = occurrence of an even number

Addition rule of probability

p(A or B) = p(A) + p(B) p(A and B) becomes p(A or B) = p(A) + p(B)

EVENTS THAT ARE COLLECTIVELY EXHAUSTIVE

Events for which the probability of their union = 1 are called collectively exhaustive events. Example: Rolling a die with Event A = occurrence of an odd number Event B = occurrence of an even number

p(A) + p(B) = 1

ADDITION RULE OF PROBABILITY: 3 EVENTS

The probability of the union of three events A, B and C p(A or B or C) = p(A) + p(B) + p(C) - p(A and B) p(A and C) p(B and C) + p(A and B and C) EXAMPLE: Rolling a die Event A: Occurrence of an even number (E2, E4, E6) Event B: Occurrence of a number < 5 (E1, E2, E3, E4) Event C: Occurrence of a number > 2 (E3, E4, E5, E6) Compute p(A or B or C) after drawing the Euler diagram.

MULTIPLICATION RULE OF PROBABILITY (Statistically independent events)

Two events, A and B, are statistically independent if the probability of one events occurring is unaffected by the occurrence of the other. Example: Drawing two cards from a pack with replacement p(A) = p(A|B) where p(A|B) is probability of A occurring given that B has occurred.

EXAMPLE: Rolling a die and tossing a coin together Event A: Occurrence of a head Event B: Occurrence of the number 4 Compute p(A) and p(A|B) after drawing the Euler diagram. Are the events statistically independent?

MULTIPLICATION RULE OF PROBABILITY (Statistically dependent events)

Two events, A and B, are statistically dependent if the probability of one events occurring is affected by the occurrence of the other. Example: Drawing two cards from a pack without replacement p(A) p(A|B) where p(A|B) is probability of A occurring given that B has occurred.

EXAMPLE: Students in the MBA programme Event A: Student having taken a loan Event B: Student being a junior Compute p(A), p(B) and p(A|B) after drawing the table of events see next slide.

MULTIPLICATION RULE OF PROBABILITY (Statistically dependent events)

Junior student Senior student

Loan taken
Loan not taken

17 students

23 students

Total: 40

46 students
Total: 63

37 students
Total: 60

Total: 83

EXAMPLE: Students in the MBA programme Event A: Student having taken a loan Event B: Student being a junior Compute p(A), p(B) and p(A|B) after drawing the table of events.

MULTIPLICATION RULE OF PROBABILITY (Statistically dependent events)

CONDITIONAL PROBABILITY RULE
p(A|B) = p(A and B)/p(B) p(B|A) = p(A and B)/p(A) Apply this to the previous slide.

MULTIPLICATION RULE OF PROBABILITY Given two events A and B, the probability of occurrence of both A and B jointly is given by: p(A and B) = p(A) * p(B|A) = p(B) * p(A|B)

MULTIPLICATION RULE OF PROBABILITY Three events

MULTIPLICATION RULE OF PROBABILITY Given three events A, B and C, the probability of occurrence of A, B and C jointly is given by: p(A and B and C) = p(A) * p(B|A) * p(C|A and B) Example: Sampling without replacement

EXERCISE 3 OF HANDOUT

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