Statistics for Business and Economics (14e)

Statistics for
Business and Economics (14e)
and Essentials of Statistics for Business and Economics (9e)

Anderson, Sweeney, Williams, Camm, Cochran, Fry, Ohlmann

© 2020 Cengage Learning

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 Statistics for Business and Economics (14e)

Chapter 4 - Introduction to Probability

4.1 - Random Experiments, Counting Rules, and Assigning Probabilities
4.2 - Events and Their Probability
4.3 - Some Basic Relationships of Probability
4.4 - Conditional Probability
4.5 - Bayes’ Theorem

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 Statistics for Business and Economics (14e)

Uncertainties
• Managers often base their decisions on an analysis of uncertainties such as the
following:
• What are the chances that the sales will decrease if we increase prices?
• What is the likelihood a new assembly method will increase productivity?
• What are the odds that a new investment will be profitable?

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 Statistics for Business and Economics (14e)

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 zero indicates an event is quite unlikely to occur.
• A probability near one indicates an event is almost certain to occur.

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 Statistics for Business and Economics (14e)

Statistical Experiments
• In statistics, the notion of an experimental differs somewhat from that of an
experiment in the physical sciences.
• In statistical experiments, probability determines outcomes.
• Even though the experiment is repeated exactly the same way, an entirely
different outcome may occur.
• For this reason, statistical experiments are sometimes called random
experiments.

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 Statistics for Business and Economics (14e)

Random Experiment and Its Sample Space (1 of 2)

• A Random experiment is a process that generates well-defined experimental
outcomes.
• The sample space for an experiment is the set of all experimental outcomes.
• An experimental outcome is also called a sample point.
Experiment Experimental Outcomes
Toss a coin Head, tail
Inspect a part Defective, non-defective
Conduct a sale call Purchase, no purchase
Roll a die 1, 2, 3, 4, 5, 6
Play a football game Win, lost, tie

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 Statistics for Business and Economics (14e)

Random Experiment and Its Sample Space (2 of 2)

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 $1000s):

Markey Oil Collins Mining

10 8
5 -2
0 EMPTY CELL

-20 . EMPTY CELL

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 Statistics for Business and Economics (14e)

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.

Markley Oil: n1 = 4

Collins Mining: n2 = 2

Total number of experimental outcomes: (4)(2) = 8.

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 Statistics for Business and Economics (14e)

Tree Diagram (1 of 2)
Example: Bradley Investments

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 Statistics for Business and Economics (14e)

Counting Rule for Combinations

• Number of Combinations of N Objects Taken n at a Time
• A second 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.

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 Statistics for Business and Economics (14e)

Counting Rule for Permutations

• Number of Permutations of N Objects Taken n at a Time
• 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.

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 Statistics for Business and Economics (14e)

Assigning Probabilities (1 of 2)
Basic Requirements for Assigning Probabilities
1. The probability assigned to each experimental outcome must be between 0
and 1, inclusively.

where Ei is the i th experimental outcome and P(Ei) is its probability

2. The sum of the probabilities for all experimental outcomes must equal 1.

where n is the number of experimental outcomes.

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 Statistics for Business and Economics (14e)

Assigning Probabilities (2 of 2)
• Classical Method
Assigning probabilities based on the assumption of equally likely outcomes
• Relative Frequency Method
Assigning probabilities based on experimental or historical data
• Subjective Method
Assigning probability based on judgment.

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 Statistics for Business and Economics (14e)

Classical Method
Example: Rolling a Die
If an experiment has n possible outcomes, the classical method would assign a
probability of 1/n to each outcome.

Experiment: Rolling a die

Sample Space: S = {1, 2, 3, 4, 5, 6}

Probabilities: Each sample point has a 1/6 chance of occurring

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 Statistics for Business and Economics (14e)

Relative Frequency Method

Example: Lucas Tool Rental
Lucas Tool Rental would like to assign probabilities to the number of car polishers it rents
each day. Office records show the following frequencies of daily rental for the last 40 days.
Each probability assignment is given by dividing the frequency (number of days) by the
total frequency (total number of days).
Number of Polishers Rented Number of Days Probability
0 4 .10 = 4/40
1 6 .15
2 18 .45
3 10 .25
4 2 .05
sum 40 1.00

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 Statistics for Business and Economics (14e)

Subjective Method (1 of 2)
• When economic conditions or 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 estimate.

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 Statistics for Business and Economics (14e)

Subjective Method (2 of 2)
Example: Bradley Investments
An analyst made the following probability estimates.
Experimental Outcome Net Gain or Loss Probability
(10,8) $18,000 Gain 0.20
(10, –2) $8,000 Gain 0.08
(5, 8) $13,000 Gain 0.16
(5, –2) $3,000 Gain 0.26
(0, 8) $8,000 Gain 0.10
(0, –2) $2,000 Loss 0.12
(–20, 8) $12,000 Loss 0.02
(–20, –2) $22,000 Loss 0.06
Empty cell Empty cell Sum equals 1.00

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 Statistics for Business and Economics (14e)

Events and Their Probabilities (1 of 2)

• 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 experimental and assign a
probability to each, we can compute the probability of an event.

Event M = Markley Oil is Profitable

M = { (10, 8), (10, –2), (5, 8), (5, –2) }
P(M) = P(10, 8) + P(10, –2) + P(5, 8) + P(5, –2)
= 0.20 + 0.08 + 0.16 + 0.26
= 0.70

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 Statistics for Business and Economics (14e)

Events and Their Probabilities (2 of 2)

Example: Bradley Investments

Event C = Collins Mining is Profitable

C = { (10, 8), (5, 8), (0, 8), (–20, 8) }
P(C) = P(10, 8) + P(5, 8) + P(0, 8) + P(–20, 8)
= 0.20 + 0.16 + 0.10 + 0.02
= 0.48

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 Statistics for Business and Economics (14e)

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

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 Statistics for Business and Economics (14e)

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.

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 Statistics for Business and Economics (14e)

Union of Two Events (1 of 2)

The union of events A and B is the event containing all sample points that are in A
and B or both. The union of events A and B is denoted by A B.

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 Statistics for Business and Economics (14e)

Union of Two Events (2 of 2)

Example: Bradley Investments
Event M = Markley Oil is Profitable
Event C = Collins Mining is Profitable
M C = Markley Oil is Profitable OR Collins Mining is Profitable (or both are
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)
= 0.20 + 0.08 + 0.16 + 0.26 + 0.10 + 0.02
= 0.82

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 Statistics for Business and Economics (14e)

Intersection of Two Events (1 of 2)

• The intersection of events A and B is the set of all sample points that are in both A and B

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 Statistics for Business and Economics (14e)

Intersection of Two Events (2 of 2)

Example: Bradley Investments

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 Statistics for Business and Economics (14e)

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:

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 Statistics for Business and Economics (14e)

Mutually Exclusive Events

• Two events are said to be mutually exclusive if the event have no sample points in
common
• Two events are mutually exclusive if, when one event occurs, the other cannot occur.

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 Statistics for Business and Economics (14e)

Conditional Probability (1 of 2)
• The probability of an event given that another event has occurred is called a
conditional probability.
• The conditional probability of A given B has already occurred denoted by .
• A conditional probability is computed as follows:

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 Statistics for Business and Economics (14e)

Conditional Probability (2 of 2)
Example: Bradley Investments

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 Statistics for Business and Economics (14e)

Multiplication Law
• The multiplication law provides a way to compute the probability of the
intersection of two events.
• The law is written as:

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 Statistics for Business and Economics (14e)

Joint Probability Table

• Joint probabilities appear in the body of the table
• Marginal probabilities appear in the margins of the table.

Collins mining Collins mining not

Markley Oil Profitable (C) Profitable (CC) Total
Profitable (M) .36 .34 .70
Not Profitable (MC) .12 .18 .30
Total .48 .52 1.00

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 Statistics for Business and Economics (14e)

Independent Events
• If the probability of event A is not changed by the existence of event B, we would
say that events A and B and are independent.
• Two events A and B are independent if:

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 Statistics for Business and Economics (14e)

Multiplication Law for Independent Events

• The multiplication law also can be used as a test to see if two events are
independent.
• The law is written as:

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 Statistics for Business and Economics (14e)

Mutual Exclusiveness and Independence

• Do not confuse the notion of mutually exclusive events with that of independent
events.
• Two events with nonzero probability cannot both mutually exclusive and
independent.
• If one mutually exclusive event is known to occur, the other cannot; occur thus,
the probability of the other even occurring is reduced to zero (and therefore
dependent).
• Two events that are not mutually exclusive, might or might not be independent.

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 Statistics for Business and Economics (14e)

Bayes’ Theorem (1 of 2)
• Often we begin probability analysis with initial or prior probabilities.
• Then, from a sample, special report, or a product test we obtain some additional
information.
• Given this information, we calculate revised or posterior probabilities.
• Bayes’ theorem provides the means for revising the prior probabilities.

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 Statistics for Business and Economics (14e)

Bayes’ Theorem (2 of 2)
A proposed shopping center will provide strong competition for downtown
businesses like L. S. Clothiers. If the shopping center is built, the owner of L. S.
Clothiers feels it would be best to relocate to the shopping center.
The shopping center cannot be built unless a zoning change is approved by the
town council. The planning board must first make a recommendation, for or
against the zoning change, to the council.
Let: A1 = town council approves the zoning change
A2 = town council disapproves the change

Using subjective judgment:

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 Statistics for Business and Economics (14e)

New Information
The planning board has recommended against the zoning change. Let B denote
the event of a negative recommendation by the planning board.
Given that B has occurred, should L. S. Clothiers revise the probabilities that the
town council will approve or disapprove the zoning change?

Past history with the planning board and the town council indicates the following:
Hence:

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 Statistics for Business and Economics (14e)

Tree Diagram (2 of 2)
Example: L. S. Clothiers

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 Statistics for Business and Economics (14e)

Bayes’ Theorem
• To find the posterior probability that event Ai will occur given that event B has
occurred, we apply Bayes’ theorem.

• Bayes’ theorem is applicable when the events for which we want to compute
posterior probabilities are mutually exclusive and their union is the entire
sample space.

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 Statistics for Business and Economics (14e)

Posterior Probabilities (1 of 2)
Example: L. S. Clothiers
Given the planning board’s recommendation not to approve the zoning change, we
revise the prior probabilities as follows:

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 Statistics for Business and Economics (14e)

Posterior Probabilities (2 of 2)
The planning board’s recommendation is good news for L. S. Clothiers. The
posterior probability of the town council approving the zoning change is 0.34
compared to a prior probability of 0.70.

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 Statistics for Business and Economics (14e)

Bayes’ Theorem: Tabular Approach (1 of 6)

Step 1:
Prepare the following three columns:
Column 1 - The mutually exclusive events for which posterior probabilities are
desired.
Column 2 - The prior probabilities for the events.
Column 3 - The conditional probabilities of the new information given each
event.

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 Statistics for Business and Economics (14e)

Bayes’ Theorem: Tabular Approach (2 of 6)

Example: L. S. Clothiers, Step 1

(1) (2) (3) (4) (5)
Events Prior Conditional
. .

Probabilities Probability
Ai P(Ai) P(B|Ai)
. .

A1 .7 .2
. .

A2 .3 .9
. .

1.0
. . . .

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 Statistics for Business and Economics (14e)

Bayes’ Theorem: Tabular Approach (3 of 6)

Step 2: Prepare the fourth column
Column 4: Compute the joint probabilities for each event and the new information
B by using the multiplication law. Multiply the probabilities in column 2 by the
corresponding conditional probabilities in column 3. That is,
(1) (2) (3) (4) (5)
Prior Conditional Joint
Events Probabilities Probability Probabilities .

Ai P(Ai) P(B|Ai) P(Ai|B)

.

A1 .7 .2 .14 = .7(.2)
.

A2 .3 .9 .27
.

. . . .

1.0

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 Statistics for Business and Economics (14e)

Bayes’ Theorem: Tabular Approach (4 of 6)

Step 2 (continued)
We see that there is a 0.14 probability of the town council approving the zoning
change and a negative recommendation by the planning board.
There is a 0.27 probability of the town council disapproving the zoning change and
a negative recommendation by the planning board.

Step 3
Sum the joint probabilities in Column 4. The sum is the probability of the new
information, P(B). The sum 0.14 + 0.27 shows an overall probability of 0.41 of a
negative recommendation by the planning board.

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 Statistics for Business and Economics (14e)

Bayes’ Theorem: Tabular Approach (5 of 6)

Example: L.S Clothiers, Step 3
(1) (2) (3) (4) (5)

Prior Conditional Joint EMPTY CELL

Events Probabilities Probability Probabilities

Ai P(Ai) P(B|Ai) P(Ai|B) EMPTY CELL

A1 .7 .2 .14 = .7 (.2) EMPTY CELL

A2 .3 .9 .27 EMPTY CELL

1.0 P(B) = .41

. .

EMPTY CELL

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 Statistics for Business and Economics (14e)

Bayes’ Theorem: Tabular Approach (6 of 6)

Step 4
Prepare the fifth column: Column 5
Compute the posterior probabilities using the basic relationship of conditional
probability.
(1) (2) (3) (4) (5)
Prior Conditional Joint Posterior
Events Probabilities Probability Probabilities Probabilities
Ai P(Ai) P(B|Ai) P(Ai|B) P(Ai|B)
A1 .7 .2 .14 = .7(.2) .3415 = .14/.41
A2 .3 .9 .27 .6585
EMPTY CELL
1.0 . EMPTY CELL
P(B) = .41 1.0000

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 Statistics for Business and Economics (14e)

End of Chapter 4

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