Introduction to Probability

(Chapter 4)
MBA I602
Economics and Business Statistics

Instructor
Dr. Behrouz Bakhtiari
Outline

■ 4.1 Fundamental Probability Concepts

■ 4.2 Rules of Probability
■ 4.3 Contingency Tables and Probabilities
■ 4.4 The Total Probability Rule and Bayes’ Theorem
Motivation: Introductory Case
▪ A manager at 24/7 Fitness Center wants to develop a data-
driven strategy for selecting which new open house
attendees to contact.
▪ Data are available from 400 past open house attendees.

▪ Using the sample information:

a. Construct a contingency table and use it to calculate and interpret
relevant empirical probabilities concerning age and enrollment.
b. Use the empirical probabilities to develop a data-driven strategy
for selecting open house attendees.
Fundamental Probability Concepts
Definitions

■ Probability (𝒑): A numerical value that measures the likelihood that an event occurs
– 0≤𝑝≤1
– 𝑝 = 0 → impossible events
– 𝑝 = 1 → definite events
■ Experiment: A process that leads to one of several possible outcomes
■ Sample space (𝑺): All possible outcomes of an experiment
– Toss of a fair die: 𝑆 = {1,2,3,4,5,6}
– Flip of a coin: 𝑆 = 𝐻, 𝑇
■ Event: Any subset of outcomes of the experiment
– An event is called a simple event if it contains a single outcome
– Events are exhaustive if all possible outcomes of an experiment belong to the
events
– Events are mutually exclusive if they do not share any common outcome of an
experiment.
Fundamental Probability Concepts
Combining Events

■ Union of events 𝐴 and 𝐵, denoted 𝑨 ∪ 𝑩, is the event consisting of all outcomes

in 𝐴 or 𝐵.
■ Intersection of events 𝐴 and 𝐵, denoted 𝑨 ∩ 𝑩, is the event consisting of all
outcomes shared in A and B.
■ Complement of event A, denoted Ac, is the event consisting of all outcomes in the
sample space S that are not in A.
Fundamental Probability Concepts
Combining Events

Example: A snowboarder competing in the Then

Winter Olympic Games is trying to assess her
probability of earning a medal in her event, ■ 𝐴 ∪ 𝐵 = Gold, Silver, Bronze, No Medal
the ladies’ halfpipe.
■ 𝐵 ∪ 𝐶 = Silver, Bronze, No Medal
■ Sample space
■ 𝐴 ∩ 𝐵 = Silver, Bronze
𝑆 = 𝐺𝑜𝑙𝑑, 𝑆𝑖𝑙𝑣𝑒𝑟, 𝐵𝑟𝑜𝑛𝑧𝑒, 𝑁𝑜 𝑀𝑒𝑑𝑎𝑙
Let ■ 𝐵 ∩ 𝐶 = No Medal

■ 𝐴 = Gold, Silver, Bronze ■ 𝐴 c = No Medal

■ 𝐵 = Silver, Bronze, No Medal ■ 𝐵 c = Gold

■ 𝐶 = No Medal ■ 𝐶 c = Gold, Silver, Bronze

Fundamental Probability Concepts
Defining Properties of Probability

▪ Denote probability of any event 𝐴 by 𝑃(𝐴)

▪ 0 ≤ 𝑃(𝐴) ≤ 1
▪ The sum of the probabilities of any list of mutually exclusive
and exhaustive events equals 1
▪ There are three types of probabilities.
— Subjective: calculated by drawing on personal and subjective
judgement
— Empirical: calculated as a relative frequency of occurrence
— Classical: based on logical analysis
▪ Empirical and classical probabilities do not vary, they are
often grouped as objective probabilities.
Probability Concepts (Example)
Assigning Probabilities

Subjective Probability Event Probability

■Guess, belief, judgment Gold medal 0.10
Let
Silver medal 0.15
■ 𝐴 = Gold, Silver, Bronze Bronze medal 0.20
■ 𝐵 = Silver, Bronze, No Medal No medal 0.55
■ 𝐶 = No Medal
Then
■ 𝑃 𝐴 = 𝑃 𝐺𝑜𝑙𝑑 + 𝑃 𝑆𝑖𝑙𝑣𝑒𝑟 + 𝑃 𝐵𝑟𝑜𝑛𝑧𝑒 = 0.10 + 0.15 + 0.20 = 0.45
■ 𝑃 𝐵 ∪ 𝐶 = 𝑃 Silver + 𝑃 Bronze + 𝑃 𝑁𝑜𝑀𝑒𝑑𝑎𝑙 = 0.15 + 0.20 + 0.55 = 0.90
■ 𝑃 𝐴 ∪ 𝐶 = 𝑃 𝐺𝑜𝑙𝑑 + 𝑃 Silver + 𝑃 Bronze + 𝑃 𝑁𝑜𝑀𝑒𝑑𝑎𝑙 = 0.10 + 0.15 + 0.20 + 0.55 = 1
■ 𝑃 𝐴∩𝐶 = 𝑃 ∅ = 0
Probability Concepts (Example)
Assigning Probabilities

Empirical Probability Relative Frequency Distribution of Ages of 400 Richest Americans

Ages Event Frequency Relative Frequency
■ Observed relative frequency
< 40 A 13 13/400 = 0.0325
40 up to 50 B 24 0.0600
50 up to 60 C 67 0.1675
60 up to 70 D 113 0.2825
13 70 up to 80 E 117 0.2925
𝑃 𝐴 = = 0.0325
400 80 up to 90 F 55 0.1375
13 + 24 + 67
𝑃 𝐴∪𝐵∪𝐶 = = 0.26 ≥ 90 G 11 0.0275
400
𝑃 𝐴 ∪ 𝐵 ∪ 𝐶 = 0.0325 + 0.0600 + 0.1675 = 0.26
Fundamental Probability Concepts
Assigning Probabilities

Classical Probability
▪ Probabilities deduced from reasoning about the problem
— Rolling a fair six-sided die (𝑆 ={1,2,3,4,5,6})
— P({1})= P({2})= P({3})= P({4})= P({5})= P({6})=1/6
— P({2} or {6}) = P({2}) + P({6}) = 1/6 + 1/6 = 1/3

Law of Large Numbers (LLN)

▪ The empirical probability approaches the classical
probability if the experiment is run a very large number of
times.
Rules of Probability

■ Complement Rule
𝑃 𝐴c = 1 − 𝑃 𝐴
■ Addition Rule
𝑃 𝐴∪𝐵 =𝑃 𝐴 +𝑃 𝐵 −𝑃 𝐴∩𝐵
Exercise
▪ Anthony feels that he has a 75% chance of getting an 𝐴 in
Statistics (event 𝐴) and a 55% chance of getting an 𝐴 in
Managerial Economics (event B). He also believes he has a
40% chance of getting an 𝐴 in both classes.
▪ What is the probability that he gets an A in at least in one of
these courses?
▪ What is the probability that he doesn’t get an A in any of
these courses?
Rules of Probability

■ Conditional Probability

𝑃 𝐴∩𝐵
𝑃 𝐴𝐵 =
𝑃 𝐵
Rules of Probability (Example)
Example: Economic globalization is defined as the integration of national economies into the
international economy through trade, foreign direct investment, capital flows, migration, and
the spread of technology. An economist predicts a 60% chance that country A will perform
poorly (event 𝐴) and a 25% chance that country B will perform poorly (event 𝐵). There is also
a 16% chance that both countries will perform poorly (event 𝐴 ∩ 𝐵).
𝑃 𝐴 = 0.60 , 𝑃 𝐵 = 0.25 , 𝑃 𝐴 ∩ 𝐵 = 0.16
■ The probability that country A performs poorly given that country B performs poorly
𝑃 𝐴∩𝐵 0.16
𝑃 𝐴𝐵 = = = 0.64
𝑃 𝐵 0.25
■ The probability that country B performs poorly given that country A performs poorly
𝑃 𝐵∩𝐴 0.16
𝑃 𝐵𝐴 = = = 0.27
𝑃 𝐴 0.60
 Rules of Probability (Example)
Independent vs. Dependent Events
■ Two events, A and B, are independent if and only if 𝑃(𝐴 ∣ 𝐵) = 𝑃(𝐴) or, equivalently, 𝑃(𝐵 ∣ 𝐴) =
𝑃(𝐵). Otherwise, the events are dependent.
■ This means: Events 𝐴 and 𝐵 are independent if and only if 𝑃 𝐴 ∩ 𝐵 = 𝑃 𝐴 𝑃(𝐵).

Example: Suppose that for a given year there is a 2% chance that your desktop computer will
crash (event D) and a 6% chance that your laptop computer will crash (event L). Moreover,
there is a 0.12% chance that both computers will crash (event 𝐷 ∩ 𝐿). Is the reliability of the
two computers independent of each other?
𝑃 𝐷 ∩ 𝐿 = 0.0012
𝑃 𝐷 𝑃 𝐿 = 0.02 × 0.06 = 0.0012
𝑃 𝐷 ∩ 𝐿 = 𝑃 𝐷 𝑃(𝐿)
Therefore the two events are independent.
Rules of Probability

The Multiplication Rule

𝑃 𝐴∩𝐵 =𝑃 𝐴 𝐵 𝑃 𝐵

Note: Events 𝐴 and 𝐵 are independent if and only if P 𝐴 ∩ 𝐵 = 𝑃 𝐴 𝑃 𝐵

Contingency Tables and Probabilities

■ A Contingency Table shows frequencies for two qualitative

(categorical) variables, 𝑥 and 𝑦, where each cell represents a mutually
exclusive combination of the pair of 𝑥 and 𝑦 values.

Under Armour Nike Adidas

Age Group (𝑩𝟏) (𝑩𝟐) (𝑩𝟑)
Under 35 (𝑨) 174 132 90 396
35 and older (𝑨𝒄) 54 72 78 204
Total 228 204 168 600
Contingency Tables and Probabilities
Under Armour Nike Adidas
Age Group (𝑩𝟏) (𝑩𝟐) (𝑩𝟑)
Marginal Probability
396 Under 35 (𝑨) 174 132 90 396
▪ 𝑃 𝐴 = 35 and older (𝑨𝒄) 54 72 78 204
600
Total 228 204 168 600
Joint Probability
72
▪ 𝑃 𝐴𝑐 𝑎𝑛𝑑 𝐵2 =
600

Conditional Probability
174
▪ 𝑃 𝐴 𝐵1 =
228
 The Bayes’ Theorem
The Total Probability Rule

The total probability rule expresses the probability

of an event (𝐴) in terms of probabilities of the
intersection of 𝐴 with mutually exclusive and
exhaustive events (e.g. 𝐵 and 𝐵𝑐 )

𝑃 𝐴 = 𝑃 𝐴 ∩ 𝐵 + 𝑃(𝐴 ∩ 𝐵𝑐 )

Or equivalently,
𝑃 𝐴 = 𝑃 𝐴 𝐵 𝑃 𝐵 + 𝑃 𝐴 𝐵𝑐 𝑃(𝐵𝑐 )
The Bayes’ Theorem
▪ Bayes’ theorem is a procedure for updating probabilities based on
new information; it uses the total probability rule.
▪ The original probability is an unconditional probability called a prior
probability, in the sense that it reflects only what we know before
the arrival of new information.
▪ On the basis of new information, we update the prior probability to
arrive at a conditional probability called a posterior probability.
▪ The posterior probability 𝑃(𝐵|𝐴) can be found using the information
on the prior probability 𝑃(𝐵) along with conditional probabilities as
𝑃 𝐴∩𝐵 𝑃 𝐴∩𝐵
𝑃 𝐵𝐴 = =
𝑃 𝐴 𝑃 𝐴 ∩ 𝐵 + 𝑃(𝐴 ∩ 𝐵𝑐 )
𝑃 𝐴 𝐵 𝑃(𝐵)
=
𝑃 𝐴 𝐵 𝑃 𝐵 + 𝑃 𝐴 𝐵𝑐 𝑃(𝐵𝑐 )
The Bayes’ Theorem (Example)
▪ Example: In a lie-detector test, an individual is asked to answer a series of
questions while connected to a polygraph (lie detector).
▪ This instrument measures and records several physiological responses of the
individual on the basis that false answers will produce distinctive
measurements.
▪ Assume that 99% of the individuals who go in for a polygraph test tell the truth.
▪ These tests are considered to be 95% reliable.
▪ In other words, there is a 95% chance that the test will detect a lie if an
individual actually lies.
▪ Let there also be a 0.5% chance that the test erroneously detects a lie even
when the individual is telling the truth.
▪ An individual has just taken a polygraph test and the test has detected a lie.
What is the probability that the individual was actually telling the truth?
The Bayes’ Theorem (Example)
Example continued
▪ Let D and T correspond to the events that the polygraph
detects a lie and that an individual is telling the truth,
𝑃 𝑇 = 0.99 and 𝑃 𝑇 𝑐 = 0.01.
▪ We formulate 𝑃 𝐷|𝑇 𝑐 = 0.95 and 𝑃 𝐷|𝑇 = 0.005.
▪ We can use Bayes’ theorem to find
𝑃(𝐷|𝑇)𝑃(𝑇)
𝑃 𝑇|𝐷 =
𝑃 𝐷|𝑇 𝑃(𝑇) + 𝑃 𝐷|𝑇 𝑐 𝑃(𝑇 𝑐 )
0.005∗0.99
= = 0.34256
0.005∗0.99+0.95∗0.01
The Bayes’ Theorem
Example continued
▪ We can also use the below table to help solve the problem
systematically.
Bayes’ Theorem (Example)
▪ Example: Scott Myers is a security analyst for a telecommunications
firm called Webtalk.
— Although he is optimistic about the firm’s future, he is concerned that its stock
price will be considerably affected by the condition of credit flow in the
economy.
— He believes that the probability is 0.70 that credit flow will improve, and 0.30
that it will not improve at all.
— He also estimates that the probability that the stock price of Webtalk will go up
is 0.50 if credit flow improves, and is 0.10 if no improvement in credit flow
occurs.
▪ If we know that the stock price of Webtalk has gone up, what is the
probability that credit flow in the economy has improved significantly?
Exercise
▪ Let event A represent credit flow improving and event B
represent stock prices going up.
Prior Probability Conditional Joint Probability Posterior
Probability Probability
𝑃(𝐴) = 0.7 𝑃 𝐵 𝐴 = 0.5 𝑃 𝐵 ∩ 𝐴 = 0.35 𝑃 𝐴 𝐵 = 0.92
𝑃 𝐴𝑐 = 0.3 𝑃 𝐵 𝐴𝑐 = 0.1 𝑃 𝐵 ∩ 𝐴𝑐 = 0.03 𝑃 𝐴𝑐 𝐵 = 0.08
𝑃 𝐵 = 0.38

▪ We will use the multiplication rule to find the joint

probabilities, e.g., 𝑃 𝐴 ∩ 𝐵 = 𝑃 𝐵 𝐴 𝑃 𝐴 = 0.35
▪ We also find, 𝑃 𝐵 = 𝑃 𝐵 ∩ 𝐴 + 𝑃 𝐵 ∩ 𝐴𝑐 = 0.38
𝑃 𝐵∩𝐴
▪ Finally, 𝑃 𝐴 𝐵 = = 0.92
𝑃 𝐵
Thank You…!