Lecture 4

Introduction to Probability
 Lecture Outline
Experiments, Counting Rules, and Assigning
Probabilities

Events and Their Probability

Some Basic Relationships of Probability

Slide 2
 Probability
Probability is a numerical measure of the
likelihood that an event will occur.
Probability values are always assigned on a
scale from 0 to 1.
A probability near 0 indicates an event is very
unlikely to occur.
A probability near 1 indicates an event is
almost certain to occur.
A probability of 0.5 indicates the occurrence of
the event is just as likely as it is unlikely.

Slide 3
Probability as a Numerical Measure
of the Likelihood of Occurrence

Increasing Likelihood of Occurrence

0 .5 1
Probability
:

The occurrence of the event is

just as likely as it is unlikely.

Slide 4
An Experiment and Its Sample Space
An experiment is any process that generates
well-defined outcomes.

The sample space for an experiment is the set of

all experimental outcomes.

A sample point is an element of the sample

space, any one particular experimental outcome.

Slide 5
Example: Bradley Investments
Bradley has invested in two stocks, Markley
Oil and Collins Mining. Bradley has
determined that the possible outcomes of
these investments three months from now
are as follows.
Investment Gain or Loss in 3
Months (in $000)
Markley Oil Collins Mining
10 8
5 -2
0
-20

Slide 6
 A Counting Rule for
Multiple-Step Experiments
If an experiment consists of a sequence of k
steps in which there are n1 possible results
for the first step, n2 possible results for the
second step, and so on, then the total
number of experimental outcomes is given
by (n1)(n2) . . . (nk).
A helpful graphical representation of a
multiple-step experiment is a tree diagram.

Slide 7
 Example: Bradley Investments
A Counting Rule for Multiple-Step Experiments
Bradley Investments can be viewed as a two-step
experiment; it involves two stocks, each with a
set of experimental outcomes.

Markley Oil: n1 = 4
Collins Mining: n2 = 2
Total Number of
Experimental Outcomes: n1n2 = (4)(2) = 8

Slide 8
Example: Bradley Investments
Tree Diagram
Markley Oil Collins Mining Experimental
(Stage 1) (Stage 2) Outcomes
Gain 8 (10, 8) Gain $18,000
(10, -2) Gain $8,000
Lose 2
Gain 10 Gain 8 (5, 8) Gain $13,000

Lose 2 (5, -2) Gain $3,000

Gain 5
Gain 8
(0, 8) Gain $8,000
Even
Lose 2 (0, -2) Lose $2,000
Lose 20 Gain 8
(-20, 8) Lose $12,000
Lose 2 (-20, -2) Lose $22,000
Slide 9
Counting Rule for Combinations
Another useful counting rule enables us to
count the number of experimental
outcomes when n objects are to be selected
from a set of N objects.
Number of combinations of N objects taken
n at a time

 N N!
CnN =  =
 n  n !(N − n )!

where N! = N(N - 1)(N - 2) . . . (2)(1)

n! = n(n - 1)( n - 2) . . . (2)(1)
0! = 1

Slide 10
 Counting Rule for Permutations
A third useful counting rule enables us to count
the number of experimental outcomes when n
objects are to be selected from a set of N objects
where the order of selection is important.
Number of permutations of N objects taken n at
a time

 N N!
PnN = n !  =
 n  (N − n )!

Slide 11
 Assigning Probabilities
Classical Method
Assigning probabilities based on the
assumption of equally likely outcomes.
Relative Frequency Method
Assigning probabilities based on
experimentation or historical data.
Subjective Method
Assigning probabilities based on the
assignor’s judgment.

Slide 12
 Classical Method
If an experiment has n possible outcomes, this
method would assign a probability of 1/n to each
outcome.
Example
Experiment: Rolling a die
Sample Space: S = {1, 2, 3, 4, 5, 6}
Probabilities: Each sample point has a 1/6
chance of occurring.

Slide 13
 Example: Lucas Tool Rental
Relative Frequency Method
Lucas would like to assign probabilities to the
number of floor polishers it rents per day.
Office records show the following frequencies of
daily rentals for the last 40 days.

Number of Number
Polishers Rented of Days
0 4
1 6
2 18
3 10
4 2

Slide 14
 Example: Lucas Tool Rental
Relative Frequency Method
The probability assignments are given by
dividing the number-of-days frequencies by the
total frequency (total number of days).

Number of Number
Polishers Rented of Days Probability
0 4 .10 = 4/40
1 6 .15 = 6/40
2 18 .45 etc.
3 10 .25
4 2 .05
40 1.00

Slide 15
 Subjective Method
When economic conditions and a company’s
circumstances change rapidly it might be
inappropriate to assign probabilities based
solely on historical data.
We can use any data available as well as our
experience and intuition, but ultimately a
probability value should express our degree of
belief that the experimental outcome will occur.
The best probability estimates often are
obtained by combining the estimates from the
classical or relative frequency approach with the
subjective estimates.

Slide 16
Example: Bradley Investments
Applying the subjective method, an analyst
made the following probability assignments.

Exper. Outcome Net Gain/Loss Probability

( 10, 8) $18,000 Gain .20
( 10, -2) $8,000 Gain .08
( 5, 8) $13,000 Gain .16
( 5, -2) $3,000 Gain .26
( 0, 8) $8,000 Gain .10
( 0, -2) $2,000 Loss .12
(-20, 8) $12,000 Loss .02
(-20, -2) $22,000 Loss .06

Slide 17
 Events and Their Probability
An event is a collection of sample points.
The probability of any event is equal to the sum
of the probabilities of the sample points in the
event.
If we can identify all the sample points of an
experiment and assign a probability to each, we
can compute the probability of an event.

Slide 18
 Example: Bradley Investments
Events and Their Probabilities

Event M = Markley Oil Profitable

M = {(10, 8), (10, -2), (5, 8), (5, -2)}
P(M) = P(10, 8) + P(10, -2) + P(5, 8) + P(5, -2)
= .2 + .08 + .16 + .26
= .70
Event C = Collins Mining Profitable
P(C) = .48 (found using the same logic)

Slide 19
 Some Basic Relationships of
Probability
There are some basic probability relationships
that can be used to compute the probability of
an event without knowledge of all the sample
point probabilities.

Complement of an Event

Union of Two Events

Intersection of Two Events

Mutually Exclusive Events

Slide 20
 Complement of an Event
The complement of event A is defined to be the
event consisting of all sample points that are
not in A.
The complement of A is denoted by Ac.
The Venn diagram below illustrates the concept
of a complement.
Sample Space S

Event A Ac

Slide 21
 Union of Two Events
The union of events A and B is the event
containing all sample points that are in A or B or
both.
The union is denoted by A  B
The union of A and B is illustrated below.
Sample Space S

Event A Event B

Slide 22
 Example: Bradley Investments
Union of Two Events
Event M = Markley Oil Profitable
Event C = Collins Mining Profitable
M  C = Markley Oil Profitable
or Collins Mining Profitable
M  C ={(10, 8), (10, -2), (5, 8), (5, -2), (0, 8), (-20, 8)}
P(M  C) = P(10, 8) + P(10, -2) + P(5, 8) + P(5, -2)
+ P(0, 8) + P(-20, 8)
= .20 + .08 + .16 + .26 + .10 + .02
= .82

Slide 23
 Intersection of Two Events
The intersection of events A and B is the set of
all sample points that are in both A and B.
The intersection is denoted by A  
The intersection of A and B is the area of
overlap in the illustration below.
Sample Space S
Intersection

Event A Event B

Slide 24
 Example: Bradley Investments
Intersection of Two Events

Event M = Markley Oil Profitable

Event C = Collins Mining Profitable
M  C = Markley Oil Profitable
and Collins Mining Profitable

M  C = {(10, 8), (5, 8)}

P(M  C) = P(10, 8) + P(5, 8)
= .20 + .16
= .36

Slide 25
 Addition Law
The addition law provides a way to compute the
probability of event A, or B, or both A and B
occurring.
The law is written as:

P(A  B) = P(A) + P(B) - P(A  B)

Slide 26
 Example: Bradley Investments
Addition Law
Markley Oil or Collins Mining Profitable
We know: P(M) =.70, P(C) = .48, P(M  C) = .36
Thus: P(M  C) = P(M) + P(C) - P(M  C)
= .70 + .48 - .36
= .82
This result is the same as that obtained earlier
using the definition of the probability of an
event.

Slide 27
 Mutually Exclusive Events
Two events are said to be mutually exclusive if
the events have no sample points in common.
That is, two events are mutually exclusive if,
when one event occurs, the other cannot occur.

Sample
Space S

Event A Event B

Slide 28
 Mutually Exclusive Events
Addition Law for Mutually Exclusive Events

P(A  B) = P(A) + P(B)

Slide 29