i.

INTRODUCTION TO PROBABILITY

Probability theory is an important part of statistical theory that bridges

descriptive and inferential statistics. It is the science of uncertainty or chance, or
likelihood.
A probability value ranges between 0 and 1 inclusive and represents the
likelihood that a particular event will happen.
A probability value of 0 means there is no chance that an will happen and a
value of 1 means there is 100 percent chance that the event will happen.
Understanding probability is helpful for decision-making.
Conducting an experiment or sample test provides an outcome that can be used
to compute the chance of events occurring in the future. An experiment is the
observation of some activity or the act of taking some measurement. Whereas,
an outcome is a particular result of an experiment. The collection of one or
more outcomes of an experiment is known as an event.
For example, a market testing of a sample of new breakfast cereal, new drink,
new shoes, new magazine, etc. gives the Director of Production or Director of
Marketing a company a preliminary idea (outcome) whether consumers would
like the product if it is produced and distributed in bulk.

ii.

CLASSIFICATION OF PROBABILITY:

1) CLASSICAL PROBABILITY
2) EMPIRICAL PROBABILITY
3) SUBJECTIVE PROBABILITY

1) CLASSICAL PROBABILITY
When there are n equally likely outcomes to an experiment.

The probability of certain events is already known or the resulting probabilities

are definitive. For example:
(A) The chance that a woman gives birth to a male or female baby (p = 0.50 or ),
(B) The chance that tail or head appears in a toss of coin (p = 0.50 or ),
(C) The chance that one spot will appear in die-rolling (p = 0.16 or 1/6).

2) EMPIRICAL PROBABILITY
The second one is empirical probability that is based on past experience.
The empirical probability, also known as relative frequency, or experimental
probability.

For example:
(A) 383 of 751 business graduates were employed in the past. The probability that
a particular graduate will be employed in his or her major area is 383/751 = 0.51
or 51%.
(B) The probability that your income tax return will be audited if there are two
million mailed to your district office and 2,400 are to be audited is
2,400/2,000,000 = 0.0012 or 0.12%.

3) SUBJECTIVE PROBABILITY
Subjective probability is a probability assigned to an event based on whatever
evidence is available. It is an educated guess. Unlike empirical probability, it is not
based on past experience. Subjective probability is obtained by evaluating the
available options and by assigning the probability. Examples of events that require
computing subjective probability:
(A) Estimating the probability that a person wins a lottery.
(B) Estimating the probability that the GM will lose its first ranking in the car sales.

iii. EVENTS
Events can be classified as:-

1)
2)
3)
4)
5)

MUTUALLY EXCLUSIVE EVENT

JOINT EVENT
INDEPENDENT EVENT
CONDITIONAL EVENT
COMPLEMENT EVENT

Combining probabilities of events requires using the rules of addition and

multiplication (see table below).

1) MUTUALLY EXCLUSIVE EVENT

Two events are mutually exclusive if by virtue of one event happening of other
cannot happen. For example, A business cant be bankrupt, break-even and
profitable at the same. It can only be one of the three. Similarly, being a male or
female are mutually exclusive and collectively exhaustive events. None one is both
and everyone is one or the other.
Example: The two most common primary causes of death in the US are heart
attack and cancer.

Heart attack is the cause for one-third (0.33) of the Americans who die each year
and cancer is the cause for one-fifth (0.20) of the deaths each year. If 2003 is like
2002, the probability that a randomly selected American will die of either a heart
attack or cancer is the sum of these two
probabilities. 0.33 + 0.20 = 0.53. [Special Rule of Addition].

2) JOINT EVENT
Events are joint if two or more events happen at the same time. For example,
driving autos is one event and talking on the cell phone is another event. When
you see someone talking on the cell phone while driving an automobile it is a
joint event.
Example: If 90% of the Citibank customers have a saving account, 40% have a
market rate account, and 60% have both, the probability that a randomly selected
Citibank customer will have either saving or market rate account will be computed
as:
0.90 + 0.40 0.60 = 0.70 [General Rule of Addition].

3) INDEPENDENT EVENT
Events are independent if the occurrence of one event does not affect the
occurrence of another event.
Example:
Suppose the probability that a student gets an A grade is 0.50 in statistics and
0.60 in History.Assume that the grade received in statistics is independent of the
grade received in History. The probability that the student will receive an A
grade in both subjects (statistics and History) is computed as:
(0.50) x (0.60) = 0.30 [Special Rule of Multiplication].

4) CONDITIONAL EVENT
Events are conditional if a particular event occurs given that another event
has occurred. Bayesian theorem can be used to revise prior probabilities and

validate earlier decisions.

For example: Three defective electric toothbrushes were accidentally shipped to a
drugstore by Clean-brush products along with 17 non-defective ones.
A) What is the probability that the first two electric toothbrushes sold will be
returned to the drugstore because they are defective?
(3/20) + (2/19) = 6/380 = 0.01579 [General Rule of Multiplication].
B) What is the probability that the first two electric toothbrushes sold will not be
defective?
(17/20) + (16/19) = 272/380 = 0.7158 [General Rule of Multiplication].

5) COMPLEMENT EVENT
The set of all possible outcomes of an experiment is known as sample space.
The sample space for die-rolling is {1,2,3,4,5,6}. An event in the sample space that
is not part of the specified event is known as the complement. Under conditions
where one even occurs as a subset of another event, the probability of the first
event cannot be higher than the probability of the one for which it is a subset.
Example: Suppose the probability that mortgage loans are approved by lenders in
your state is 0.70 (70%). By the complement rule, the probability that loans may
not be approved for a randomly selected applicant is 0.30 (30%). 1 - .70 = .30

iv. PROBABILITY DISTRIBUTION

A probability distribution is a set of probabilities describing the chances of
events to occur. Any frequency distribution can be turned into an empirical
probability distribution.
When we calculate the distribution from a finite sample, it is a frequency
distribution.
How is it calculated?
Let us take some data. In order to obtain a distribution, we divide the data into
different classes or groups (like different age groups in a class or at a place). We
check how many data fall into a class or group. The ratio of the number in a class
(class frequency) to the total number of data is called the relative frequency.
The relative frequency is assumed to be the empirical probability. We generally
represent them graphically through a bar diagram. This empirical probability
tends towards actual probability P(x) at some point x when we take the number of
data to be very large. The distribution curve is a plot of P(x) against x where
P(x) is the probability for the data point x to occur.
There are some well known probability distributions:-

1) DISCRETE PROBABILITY DISTRIBUTION

2) CONTINUOUS PROBABILITY DISTRIBBUTION
3) NORMAL DISTRIBUTION

1) DISCRETE PROBABILITY DISTRIBUTION

It describes a finite set of possible occurrences, for discrete count data. For
example, the number of successful treatments out of 2 patients is discrete,
because the random variable represent the number of success can be only 0, 1, or
2. The probability of all possible occurrencesPr(0 successes), Pr(1 success), Pr(2
successes)constitutes the probability distribution for this discrete random
variable.
There are 2 types for further depth:-

A)

BIONOMIAL DISTRIBUTION.

B)

POISSON DISTRIBUTION.

A)

BIONOMIAL DISTRIBUTION

Two possible outcomes: Success (S) and Failure (F).Repeat the situation
ntimes (i.e., there are n trials).The "probability of success," p, is constant on
each trial. The trials are independent.

The probability notation summary for different values of P (x) is given in the table
below. It is important to understand the meaning of terms such as at least,
more than, at most, less than, between X1 and X2 inclusive, and
between X1 and X2. They indicate cumulative binomial probabilities that
involve adding the values up or down.

Example:
Suppose AAA road emergency service has been 60% successful in the past
reaching its customers within 30 minutes. What is the probability of obtaining
three successful calls within an acceptable time in a sample of five monitored
service calls in this particular sequence?
This problem can be solved in three different ways.
1) It can be computed using the binomial probability distribution formula. In the
above problem:

B) POISSON DISTRIBUTION
The Poisson distribution is a probability distribution of a discrete random
variable that stands for the number (count) of statistically independent
events, occurring within a unit of time or space.
Wolfram Math World (2012) arrives at this distribution by taking the limit of
the Binomial (Bernoulli) distribution when the number, N, of trials becomes
very large Binomial random variable represents the number of successes in
a series of independent and probabilistically A homogenous trials.

2) CONTINUOUS PROBABILITY DISTRIBUTION

It describes an unbroken continuum of possible occurrences. For example, the
probability of a given birth weight can be anything from, say, half a pound to more
than 12 pounds (or something like that). Thus, the random variable of birth weight
is continuous, with an infinite number of possible points between any two values.

3) NORMAL PROBABILITY DISTRIBUTION

One particular continuous probability distribution is normal distribution. It is a
symmetric, bell-shaped distribution that takes a normal random variable, with
being the mean of the normal random variable, X being any value below or
above , and being the standard deviation from the center of distribution.
Properties of the normal probability distribution:
The normal curve is bell shaped and has a single peak at the exact center
of the distribution.
The mean, median, and mode of distribution are equal and located at the
peak.
Half of the area under the curve is above the peak, and other half is below
it.
There are several families of the normal distribution curve. The standard one has
a random variable Z, = 0 and = 1. Based on the Empirical Rule, there are 3
on each side of the curve. Probability value is zero at 4 and beyond from the
center.
The probability values for each Z-value are listed in Table A19 for Z value located
to the left of and in the same table for the Z-value located to the right of ). As
explained in Week Three Lecture, the Z-value measures the number of standard
deviations that a data value is from the population mean. The value of Z is
obtained using the formula:
Z = X (s can be substituted for if the population parameter is unknown)

A negative Z value shows that the random variable is located to the left of and
a positive Z value means the random variable is located to the right of the center.
The rules for solving different normal probability problems are given below

The distribution is symmetric and the peak (most probable value) of a normal
distribution occurs at x x (mean value).

Approximately 95% of area under curve falls within 2 SDs on either side of
mean, and about 68% of the area falls within 1 SD from mean. Total area
under the curve is 100%.
The mathematical formula for the above normal curve is

where "exp" denotes the exponential function, e = 2.71828. The distribution is

symmetric and the peak (most probable value) of a normal distribution occurs at x
x (mean value).

Example:
The amount of money requested in home loan applications at Dawn River Federal
Savings are approximately normally distributed with = $70,000 and = $20,00.
A loan application is received this morning. What is the probability that:
A) the amount requested is $80,000 or more? The answer is 0.3085. Using
Z = X / , Z = 80,000 70,000/20000 = 0.5. When Z = 0.50,
the probability area is 0.3085 in standard normal table or 1.00 0.6915 =
0.3085.
B) The amount requested is less than $65,000? The answer is 0.4012. Using Z =
X / , Z = 65,000 70,000/20000 = -0.25. This can be directly obtained
from standard normal table, using row Z = -0.2 and column 0.05.

V. APPLICATION IN REAL BUSINESS

ENVIRONMENT
PROBABILITY IN MANUFACTURING
Manufacturing businesses can use probability to determine the costbenefit ratio or the transfer of a new manufacturing technology
process by addressing the likelihood of improved profits. In other
instances, manufacturing firms use probability to determine the
possibility of financial success of a new product when considering
competition from other manufacturers, market demand, market value
and manufacturing costs. Other instances of probability in
manufacturing include determining the likelihood of producing
defective products, and regional need and capacity for certain fields
of manufacturing.

SCENARIO ANALYSIS
Probability distributions can be used to create scenario analyses. For
example, a business might create three scenarios: worst-case, likely
and best-case. The worst-case scenario would contain some value
from the lower end of the probability distribution; the likely scenario
would contain a value towards the middle of the distribution; and the
best-case scenario would contain a value in the upper end of the
scenario.

RISK EVALUATION
In addition to predicting future sales levels, probability distribution can
be a useful tool for evaluating risk. Consider, for example, a company
considering entering a new business line. If the company needs to
generate $500,000 in revenue in order to break even and their
probability distribution tells them that there is a 10 percent chance
that revenues will be less than $500,000, the company knows roughly
what level of risk it is facing if it decides to pursue that new business
line.

SALES FORCASTING
One practical use for probability distributions and scenario analysis in
business is to predict future levels of sales. It is essentially impossible

to predict the precise value of a future sales level; however,

businesses still need to be able to plan for future events. Using a
scenario analysis based on a probability distribution can help a
company frame its possible future values in terms of a likely sales
level and a worst-case and best-case scenario. By doing so, the
company can base its business plans on the likely scenario but still
be aware of the alternative possibilities.

INDEX
I.

INTRODUCTION TO PROBABILITY
what is probability?

II. CLASSIFICATION OF PROBABILITY

classical probability, empirical probability, subjective
probability.

III. EVENTS
mutually exclusive event, joint event, independent event,
conditional event, complement event.

IV. PROBABILITY DISTRIBUTION

discrete probability distribution, continuous probability
distribution, normal distribution.

V.

APPLICATION IN REAL BUSINESS

ENVIRONMENT
some examples like sales forecasting, risk analysis etc.

VI. BIBLIOGRAPHY