Chapter 4

Probability
Jacob Bernouli (1654-1705), Abraham de
Moivre (1667-1754), the Reverend Thomas
Bayes (1702-1761) and Joseph Laagrange
(1736-1813) developed probability formulas
and techniques.
Probability the was successfully applied at
the gambling tables and, more relevant to
social and economic problems.
The mathematical theory of probability is
the basis for statistical applications in both
social and decision making research.
Probability:

Basic Terminology in Probability

Two broad categories of decision making problems:
Deterministic Model
Probabilistic (Random) Models.

Probability is the chance something will happen.

Probabilities are expressed as fractions/decimals
between zero and one.
Assigning a probability of zero means that
something can never happen, a probability of one
indicates that something will always happen.
In probability theory, an event is one or more of the
possible outcomes of doing something.

Basic Terminology in Probability

Basic Terminology in Probability

The activity that produces such an event is
referred to in probability theory as an
experiment.
Events are said to be mutually exclusive if
one and only one of them can take place at
a time.
When a list of the possible events that can
result from an experiment includes every
possible outcome, the list said to be
collectively exhaustive.

Basic Terminology in Probability

Three Types of Probability

There are three basic ways of classifying
probability. These three represent rather
different conceptual approaches to the
study of probability theory:

Three Types of

Three Types of Probability

Classical Approach:
Defines Probability as ratio of favorable outcomes
to the total outcomes.
Also known as priori probability.
It assumes a number of assumptions so most
restrictive approach and it is least useful in real life
situations.

Relative Frequency Approach:

Defines Probability as observed relative frequency
of an event in a very large number of trials.
It assumes less assumptions but requires the event
to be capable of being repeated a large number of
times.
Three Types of

Three Types of Probability

Subjective Probability:
Deals with specific or unique situations typical
of the business or management world.
Based upon some belief or educated guess of
the decision maker.
Subjective assessments of probability permit
the widest flexibility of the three concepts,
also known as Personal Probability.

Three Types of

Probability Rules
Most managers who use probabilities are
concerned with two conditions:
1. The case where one event or another will occur.
2. The situation where two or more events will both
occur.

A single probability means that only one

event can take place, it is called marginal or
unconditional probability.
Addition Rule for Probability:
P ( A or B) = P (A) + P(B) P (A and B)
For Mutually Exclusive Events:
P ( A or B) = P (A) + P(B)
Probability Rules

Probabilities Under Conditions of

Statistical Independence
Occurrence of one event has no effect on the
probability of the occurrence of any other event.
There are three types of probabilities under
statistical independence
1. Marginal:
Probability of the occurrence of an event
2. Joint :
P (AB) = P(A) X P(B)
3. Conditional:
P(A/B) = P(A)
and
P(B/A) = P(B)

In statistical independence, assumption is that

events are not related.

Probabilities Under Conditions of Statistical

Probabilities Under Conditions of

Statistical Dependence
When the probability of some event is dependent on
or affected by the occurrence of some other event.
As Independent case there are three types of
probabilities under statistical independence
1.

Conditional:

P (A/B) = P(AB)/ P(B)

and
P(B/A) = P(AB)/P(A)
2. Joint:

P(AB) = P(A/B) X P(B) and

P(AB) = P(B/A) X P(A)
3. Marginal:
Marginal probabilities under statistical dependence
are computed by summing up the probabilities of all
the joint events in which the simple event occurs.

Probabilities Under Conditions of Statistical

Revising Prior Estimates of

probabilities: Bayes Theorem
Bayes Theorem expresses how a subjective degree of
belief should rationally change to account for evidence.
Probabilities can be revised as more (additional)
information is gained. New probability is known as
Posterior Probability.
In the Bayesian interpretation, Bayes' theorem is
fundamental toBayesian statistics, and has application
in fields including science, engineering, medicine and
law.
In theBayesian (or epistemological) interpretation,
probability measures adegree of belief. Bayes'
theorem then links the degree of belief in a proposition
before and after accounting for evidence.
Revising Prior Estimates of probabilities: Bayes