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Full-Time MBA: Business Statistics (BST510)

Probability and Probability


Distributions

Section four

Paul Bottomley (Room F03)


Reading: Silver pp.150-154, 163-180.

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Paul, the Psychic Octopus?
Born Sea Life Centre, January
2008 Weymouth, died 26th
October 2010 Oberhausen.

2008 European Championship:


predicted 4 / 6 Germany games.

2010 World Cup: predicted 8 / 8


results including Netherland vs.
Spain, & all 7 Germany games.

What are the odds of that? Probability = 1 / 256 = 0.004!!


Introduction to Probability
Obtain an appreciation of the role probability information
can play in managerial decision-making.
Should a salesman accept a flat-fee or commission?
Ehrenberg: brand market share law of double jeopardy.
Will changes to service delivery improve customer satisfaction?

Probability is a numerical measure of how likely an event


will occur. It involves measuring uncertainty.
Probability is also used in statistical inference what does
the sample data tell us about the whole population?

Probabilities range from 0 and 1 inclusive.


Zero = outcome is impossible; 1 = it is a certainty.
Sometimes expressed as percentages or odds: 2 to 1.

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ScotlandDNA and the Red Hair Gene
Only 1-2% of worlds population
has red hair but 13% (650k) of
Scots do.
Could be as many as 1.6m red-hair
gene carries.
Physical colouring is a mixture of
black and red/yellow melanin but
pigmentation protein MCR1 is
disrupted and black melanin is
suppressed.
Result - fair skin and red hair.

Source: BBC News (07.11.2012) Karen Gillian, Dr Whos assistant


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Sources of Probabilities
#1 Subjective approach
Based on personal assessment, expresses our beliefs.
Wales are 65% likely to beat Samoa in rugby.
A criminal is 90% likely to re-offend.
Views can differ, so dont try to be too precise.
Be careful that the probabilities sum to 1 not automatic!

#2 Objective (empirical) approach


Based on empirical evidence.
BMW breaking down within 60,000 miles, 3 year guarantee.
Taste test for three new blends of coffee.
Relative frequency the proportion of times the outcome has
occurred over many repetitions.
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Sources of Probabilities (2)
#3 Classical (a priori) approach
All outcomes are equally likely.
Each outcome has a 1/n chance (n = number of outcomes)
Flip a coin; 2 outcomes; P(head) = 1 / 2
Roll a dice; 6 outcomes; P(roll a 3) = 1 / 6

Number of favourable outcomes


Probability = Number of total possible outcomes

In many business situations, the best probability estimates


are often obtained by combining (a) classical or empirical
estimates with those of (b) managerial judgment.

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Probability: Some Key Words
An Experiment: an action/process with a well defined set
of outcomes. On any single repetition (trial), one and only 1
of the possible outcomes will occur (e.g., roll a dice).

Sample Space: set of all possible outcomes (S).


Element: a specific outcome.
S = {H, T}
S = {1, 2, 3, 4, 5, 6}
Event: subset of the sample space. It may be a specific
outcome or combination of outcomes.
Rolling a dice (number = 3)
Rolling a dice (number is divisible by 3)

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Events and their Probabilities
Probability of an Event: = sum of the probabilities of all the
elements that make up the event.
Example: 223 customers of a stationary supplier settle their
accounts every 1 or 3 months, using card, cheque or cash.

Account Card Cheque Cash Row Total


1 month 15 52 10 77
3 month 18 108 20 146
Col. Tot 33 160 30 223
P(Pay by cheque) = P(cheque, 1 month) + P(cheque, 3 month)
= (52 + 108) / 223 = 160 / 223 = 0.72

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Combining Events: Addition Rules
There are four rules of probability, two each with a specific
and a general case. The trick is how to combine them.

Addition (OR) Rule. With two events A and B, we are


interested in the probability of event A OR event B (or both).
But are the two events mutually exclusive? [Or do they
have any elements in common - happen at the same time?]

YES: Specific Rule. P(A or B) = P(A) + P(B).


Example: P(Roll a die; get a 2 or 3) = P(2) + P(3) = 2 / 6.
NO: General Rule. P(A or B) = P(A) + P(B) P(A and B)
Example: P(Quit job because of poor pay, poor conditions, or both).

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Customer Accounts: Addition Rules
Lets return to the customer accounts example.

Account Card Cheque Cash Row Total


1 month 15 52 10 77
3 month 18 108 20 146
Col.Tot 33 160 30 223

P(Pay by CC or cheque) = (33 + 160) / 223 = 193 / 223 = 0.87


P(Pay by CC or monthly) = (33 + 77 15) /223 = 95/223 = 0.43
Elements common to both events are double counted and must
be subtracted (not mutually exclusive - happen at same time)
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Combining Events Multiplication Rules
Multiplication (AND) Rule. With two events A and B, we
are interested in the probability of event A AND event B.
But are the two events independent? [Or is the chance of
event B influenced by knowing that event A has happened?]

YES: Specific Rule. P(A and B) = P(A)P(B).

Example: A petrol station manager knows from experience


80% of drivers pay by credit card (CC). What is the chance
that the next two drivers will both pay by credit card?
Let A = Driver 1 pays by CC; B = Driver 2 pays by CC
Events are independent as driver 1s decision does not influence
driver 2s decision.
P(A and B) = 0.8 x 0.8 = 0.64.
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Multiplication Rule Cont.
But are the two events independent?
NO: General Rule. P(A and B) = P(A)P(B|A).
P(B|A) is the conditional probability of event B given that event
A has already occurred.

Example: Imagine 5 candidates are short-listed for a job, 3 are


women. What is the chance 2 women are selected for further
psychometric tests? (sampling without replacement).
Event A = person 1 is female; B = person 2 is female.
Events are dependent as the chance of the second person being female
depends on whether the first person selected was female.
P(A) = 3/5, and P(B|A) = 2/4.
P(A AND B) = P(A) x P(B|A) = (3/5) x (2/4) = 6/20 = 0.30
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Summary of Basic Probability Rules

Specific General

Addition P(A) + P(B) P(A)+ P(B) - P(A&B)


P(A) OR P(B) Mutually Exc: Yes Mutually Exc: No

Multiplication P(A) x P(B) P(A) x P(B|A)


P(A) AND P(B) Independent: Yes Independent: No

But which Addition Rule? Are the events mutually exclusive?


But which Multiplication Rule? Are the events independent?

If YES ---> Specific rule; If NO ---> General rule

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What is a Random Variable?
It is a numerical description of the outcomes of an experiment.
Think of it as a quantity whose value is not fixed, but which can
take on different values from one trial to the next.
Flip 5 coins and count the number of heads.
The amount of rainfall in Cardiff on a particular day.

Discrete r.v.: can take on only some values within a range.


Number of people queuing at a supermarket checkout.
Continuous r.v.: can take on any value within a range.
Weight, time, distance travelled on a tank of petrol.
Discrete (Continuous) r.v.: the number of outcomes (not)
are countable or (in)finite.

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Some Examples of Random Variables
What are the outcomes to the following experiments? Are they
continuous or discrete random variables?

Experiment: Take a 20 question multiple choice test.


r.v. = number of correct answers; discrete (0 to 20).

Experiment: Fill a bottle of olive oil.


r.v. = volume of oil (millilitres); continuous (0 x max. capacity)

Experiment: Phone calls to an insurance claims department.


r.v. = number of calls received per hour / day; discrete.
r.v. = time between calls received; continuous.

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Probability Distributions
A probability distribution is a listing of all the possible outcomes
(values) of an experiment together with the chance of occurring.
It gives the probability of each value of a random variable.
(Strictly speaking, these definitions apply more to discrete distributions).

Discrete probability distributions have a finite number of values.


Examples: Binomial and Poisson.
Continuous distributions have an infinite number of values.
Examples: Normal and Exponential

Probabilities can be found using (i) tables, (ii) graphs or (iii)


statistical formulae.
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Scaramanga Motors, Bath
The number of sales by a local car dealer based on the last 312
(6 x 52) trading days is a discrete random variable.
30 days made zero sales; P(X = 0) = 30 / 312 = 0.096
On a typical day, most likely to make two sales; P(X = 2) = 0.471
Chance of making four or more sales; P(X = 4) + P(X = 5) = 0.08.
Outcomes are mutually exclusive, so the probabilities sum to 1.

Sales Days P(X = x)


Probability Distribution
0 30 0.096
Modal
1 70 0.224 0.5

Frequency
value
Relative
2 147 0.471
0.3
3 40 0.128
4 15 0.048 0.0
5 10 0.032 0 1 2 3 4 5
312 1.000

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The Binomial Distribution
Arises in many real world situations:
Example: flipping coins, airline meals, sales-force compensation.
It is appropriate when there are n identical trials, and we
want to know the probability of getting x successes.

Assumptions:
The n trials should be identical.
Each trial has two outcomes: success and failure.
The trials should be independent.
The probability of success (p) is constant for each trial.

Having recognised the problem, how do we apply it?


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A Simple Binomial Experiment
A coin is flipped 3 times. A head is defined as a success.
The number of successes is a random variable, range 0 to 3.
There are 8 possible outcomes (no. of heads in brackets):

TTT(0),
HTT, THT, TTH (1)
HHT, HTH, THH (2),
HHH (3)
Probability Distribution

X 0 1 2 3
P(X = x) 0.1250 0.3750 0.3750 0.1250
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The Binomial Formula
In a binomial scenario the random variable (X) of interest is
the number of trials that are successes.
To calculate the probability of x successes in n trials, we
simply substitute into the formula:
n! n x

x
P( x _ successes ) p (1 p)
(n x)! x!

The number of ways


of getting x successes Probability of Probability of
from n trials x successes n x failures

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Applying the Binomial Formula
Example: Imagine flipping a biased coin (51% chance of heads)
three times, what is the probability of getting two heads?
Solution: Apply binomial formula with n = 3, p = 0.51, x = 2.
n! x n x
P( X x) p (1 p)
(n x)! x!
This could occur if the first and second coins are heads (HHT)
This occurs with the probability 0.51 x 0.51 x 0.49
Or 0.512 x 0.491 = 0.127 (if unbiased = 0.125, 1 in 8 chance)

BUT this is only 1 sequence comprising 2 heads and 1 tail!


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Combination or Choose Function
n!
The first part of the binomial formula:
(n x)! x!
is known as the choose function. It shows the number of
ways of choosing x objects from a collection of n objects.

Check your calculator, look for nCx or nCx or n .
x
Example:
With 3 coins, how many ways are there of choosing 2 heads?

n! 3! 3 x 2 x1
3
( n x)! x! (3 2)!2! 1x 2 x1
Aside: How many ways can I choose 6 lottery balls from 49?
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Putting the Binomial Together
Returning to our biased coin example (51% heads), what is
the probability of exactly two heads from three flips?
Solution: Binomial formula with n = 3, p = 0.51, and x = 2.
n! x n x
P( X x) p (1 p)
(n x)! x!
3! 1
P ( X 2) 1 0.51)
2

(3 2)!2! 0.51 (
= 3 x 0.2601 x 0.49 = 0.3823

Number of ways of getting Probability of 2 Probability of 1


2 successes in 3 trials successes failure

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Points to Remember
When Using the Binomial Formula
n! denotes the factorial function

n! = 1 x 2 x 3 x . x (n-1) x n

Both 0! and 1! are equal to 1.

Anything raised to the power of zero always equals 1.

p0 = 1, also p1 = p

Anything raised to the power of one is itself.

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The Travelling Salesman
Q: A sales rep has observed that 1 in 5 potential customers he
visits makes a purchase. He visits on average 5 customers
per working day. What is the probability that he makes:
(i) Exactly 1 sale?
(ii) Less than 2 sales?

Solution to (i)
This is a binomial situation where n = 5, x = 1, and p = 0.2

10.2) 0.4096
5! 4
P( x 1)
1

(5 1)!1! 0.2 (

Number of ways of getting 1 Probability of 1 Probability of 4


success in 5 trials success failures
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The Cumulative Binomial Probability
Sometimes we dont want the probability of getting exactly x
successes, but the chance of getting x successes or more
(or x successes or less).
In this case, we simply add up all component probabilities.

Solution to (ii): Less than two sales translates into the


probability of zero OR one customers making a purchase.
P(x < 2) = P(x = 0) + P(x = 1)

10.2) 0.3277
5! 5
P( x 0)
0

(5 0)!0! 0.2 (
P(x < 2) = 0.41 + 0.33 = 0.74
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Graphical Illustration: Probability that
At Least 3 Customers Make a Purchase

0.45 At least 3 =
0.4 1 [P(0)+P(1)+P(2)]
0.35
0.3
Probability

0.25
0.2 At least 3 =
0.15 P(3) +P(4) + P(5)
0.1
0.05
0
0 1 2 3 4 5

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Some More Binomial Distributions
Prob. of success = 0.2 Prob. of success = 0.5
0.45 0.35
0.4
0.3
0.35
0.25
0.3
Probability

Probability
0.25 0.2

0.2 0.15
0.15
0.1
0.1
0.05
0.05
0 0
0 1 2 3 4 5 0 1 2 3 4 5

0.45 0.7
0.4 0.6
0.35
0.5
0.3
Probability

Probability
0.25 0.4
0.2 0.3
0.15
0.2
0.1
0.05 0.1

0 0
0 1 2 3 4 5 0 1 2 3 4 5

Prob. of success = 0.8 Prob. of success = 0.92


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The Poisson Distribution
Useful for estimating the number of occurrences of an event
(X) within a specific interval (e.g., time, distance, area).

0 End
Occurrence of goals in
90 minutes football match

Developed by Simeon Poissonbut perfected by McDonalds,


AT&T and other leading retailers!
Useful for approximating the Binomial when n is large and p is
small (beyond this course).

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The Poisson Distribution
Two properties / assumptions must be satisfied:

The event is expected to occur on average times during the


interval. The event occurs at the same average rate throughout
the interval.
Example: if the average number of goals in a football match is 2.8,
then the average number of goals in half a football match is 1.4.

The number of events that occur in an interval is independent of


the number of events that occur in any other non-overlapping
interval.
Example: the number of calls received at an office in the first hour does
not influence the number of calls received in the second hour.

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Poisson or Binomial Distributions?
Which of the following problems are best described by a
Poisson or Binomial probability distribution? The number of

Heads when flipping three coins?


Times lightning flashes in a day in July?
Patients admitted to an A & E department on Friday night?
Vegetarian meals required on a 20 seater executive jet?

HINT: is there a natural upper-limit?

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The Poisson Distribution Formula
If is the average number of times the event is expected
to occur in the interval, then the probability of the event
actually occurring x times in the interval is:
x
e Check your
P( X )
x! Calculators!
Where e is a constant, such that e = 2.7183
If e is raised to the power 2, e2 = 7.3891
But here e is raised to a negative power, e- = 1 / e
So if e is raised to the power 2, e-2 = 1 / 7.3891 = 0.1353

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It Only Takes A Second
Example: If the average number of goals scored during a 90
minute football match is 2.8, what is the probability exactly 5
goals will be scored during a game?

e x x
2.8 e 2.8
P( X x)
x! x!
5 2.8
2.8 e 172.10 * 0.0608
P( X 5) 0.0872
5! 120
Solution: The number of goals is the random variable. We are
interested in the chance of exactly 5 goals being scored (x = 5)
when on average () 2.8 goals are scored. Answer: 9 in 100.
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Waiting in Line
The number of people arriving at a bank is monitored for each 5
minute interval in the morning on a given day, and the mean was
found to be 2.6 people. The same exercise was undertaken in
the afternoon and found to be 2.1. What is the probability that:

(a). One person will arrive in a 5 minute interval in the morning,


and similarly in the afternoon?

(b). More than one person will arrive in a 5 minute period in


the morning, and similarly in the afternoon?

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Waiting in Line
Poisson Probability Functions:
x 2.6
2.6 e 2.1x e 2.1
a.m. : P( X ) p.m. : P( X )
x! x!
(a). One person will arrive during the 5 minute interval:
1 2.6
2.6 e 2.11 e 2.1
a.m. : P( X 1) 0.1931 p.m. : 0.2570
1! 1!

(b). More than 1 person will arrive: 1 - [P(X=0)+P(X=1)]

2.60 e 2.6 2.10 e 2.1


a.m. : P( X 0) 0.0743 p.m. : 0.1224
0! 0!
a.m. = 1 - (0.07+0.19) = 0.74 p.m. = 1 - (0.12+0.26) = 0.62
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Waiting In Line: Graphical Illustration
0.3 0.3
Probability

Probability
0.2 0.2

0.1 0.1

0 0 1 2 3 4 5 6 0 0 1 2 3 4 5 6

No upper-limit No upper-limit
Morning: Afternoon:
X=x 2.6x e-2.6 x! Prob. X=x 2.1x e-2.1 x! Prob.
0 1.00 0.0743 1 0.0743 0 1.00 0.1225 1 0.1225
1 2.60 0.0743 1 0.1931 1 2.10 0.1225 1 0.2572
2 6.76 0.0743 2 0.2510 2 4.41 0.1225 2 0.2700
3 17.58 0.0743 6 0.2176 3 9.26 0.1225 6 0.1890
4 45.70 0.0743 24 0.1414 4 19.45 0.1225 24 0.0992
5 118.81 0.0743 120 0.0735 5 40.84 0.1225 120 0.0417
6 308.92 0.0743 720 0.0319 6 85.77 0.1225 720 0.0146
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Waiting in Line Cont.
(c). What is the expected number of people arriving within any
10 minute period at the bank in the morning?

If the expected number of people in 5 minutes = 2.6


Then the expected number of people in 10 minutes = 5.2
Because people arrive at a constant rate (Assumption #1)
Poisson function for x arrivals in any 10 minute period is:

5.2 x e 5.2 1
5.2 e 5.2
a.m. : P( X ) P( X 1) 0.0287
x! 1!
Be careful: chance of 1 arrival in any 10 minute period is not
double (half) that of 1 arrival in any 5 min. period (P = 0.17).

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The Poisson Assumptions Revisited
A solicitors medical negligence claims department receives on
average 15 enquiries per 5 day week. Discuss the applicability /
validity of the Poisson assumptions to this scenario.

We know that on average 15 enquiries are received per 5 day,


so assuming events occur at a constant rate, we can expect 3
enquiries per day (mu = 3). (Assumption #1).
Or different mus for different days of the week?

The chance of receiving an enquiry on Monday is unlikely to


impact the chance of an enquiry on Tuesday (Assumption # 2)
Or is it pent up weekend demand?
Leads following TV advertisement?

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