The basic idea of probability

• The numerical measure of the likelihood that an event will occur,

expressed as a number between 0 and 1.
• A probability of 1 means absolute certainty of the occurrence of an
event and a probability of 0 means absolute certainty of its non-
occurrence.
• Let’s say an event has a probability of 0.5, e.g. the probability of
heads in a coin toss. What does it really mean?

• Experiment…
Why study probability
• Used directly in many industries and industry applications
• Insurance industry: probabilities used in actuarial tables to determine the likelihood of certain
outcomes in order to set specific rates and coverage
• Gaming industry: probability values used to establish charges and payoffs
• Manufacturing and Aerospace: expected values used to estimate life of a mechanized part
and probability that it will malfunction at any given length of time
experiment
• An experiment is a process that produces some outcomes.

• Examples of business-oriented experiments:

• Testing new pharmaceutical drugs on samples of cancer patients and measuring the patients’
improvement
• Sampling every 200th bottle of ketchup from an assembly line and weighing the contents
• Auditing every 10th account to detect any errors
event
• An event is a possible outcome of an experiment.

• Examples:
• Getting one defective and four good bottles in an experiment that samples five bottles coming
out of a production line
• Making purchase or not making a purchase upon conducting a sales call
• Demand going up, down or remaining constant upon reducing price of
a product
Sample space
• A sample space is a complete roster or listing of all elementary events for an
• experiment.
• The sample space for the roll of a single die is {1, 2, 3, 4, 5, 6}.
• The sample space for the roll of two dice is shown below:

(1,1) (2,1) (3,1) (4,1) (5,1) (6,1)

(1,2) (2,2) (3,2) (4,2) (5,2) (6,2)
(1,3) (2,3) (3,3) (4,3) (5,3) (6,3)
(1,4) (2,4) (3,4) (4,4) (5,4) (6,4)
(1,5) (2,5) (3,5) (4,5) (5,5) (6,5)
(1,6) (2,6) (3,6) (4,6) (5,6) (6,6)
Union and intersection
• The union of X, Y is formed by combining elements from each of the sets and is denoted X ∪ Y. An
element qualifies for the union of X, Y if it is in either X or Y or in both X and Y. The union
expression X ∪ Y can be translated to “X or Y.”

• The intersection contains the elements common to both sets. Thus the intersection symbol, ∩, is
often read as and. The intersection of X, Y is referred to as X and Y.
Complements
• The complement of event A is denoted A , pronounced “not A.” All the elementary
events of an experiment not in A comprise its complement.

• Consider the case of a sales manager who, after reviewing sales reports, states that
80% of new customer contacts result in no sale. By allowing A to denote the event of
a sale and A’ to denote the event of no sale, the manager is stating that P (A’) = 0.80.
So,
P(A) = 1 – P(A’) = 1 – 0.80 = 0.20
• We can conclude that a new customer contact has a 0.20 probability of resulting in a
sale
Example
• A spinner has 4 equal sectors colored yellow, blue, green and red.
What is the probability of landing on a sector that is not red after
spinning this spinner?

• A single card is chosen at random from a standard deck of 52 playing

cards. What is the probability of choosing a card that is not a king?
ODDS
The odds of an event presents the probability as a ratio of
success to failure. This is common in various gambling formats.
Mathematically, the odds of an event can be defined as:
P(A)
1 − P(A)
where P(A) is the probability of success and of course 1 − P(A) is
the probability of failure. Odds are always quoted as
"numerator to denominator," e.g. 2 to 1. Here the probability of
winning is twice that of losing; thus, the probability of winning
is 0.66. A probability of winning of 0.60 would generate odds in
favor of winning of 3 to 2. While the calculation of odds can be
useful in gambling venues in determining payoff amounts, it is
not helpful for understanding probability or statistical theory.
Counting the possibilities
With order
• Permutation: all orderly arrangements of ‘r’ out of ‘n’
• n= a , b, c
• Arrangements of 2
(a,b) (a,c) (b,a) (b,c) (c,a) (c,b)
Without order
• All non orderly arrangements of ‘r’ objects out of ‘n’
• n= a, b, c
• Arrangements of 2
• (a,b) (a,c) (b,c)
• Combination: Picking a team of 3 people from a group of 10.
• Permutation: Picking a President, VP and Waterboy from a group of
10.
• Choosing 3 desserts from a menu of 10.
• Listing your 3 favorite desserts, in order, from a menu of 10.
• How many words can be formed by using 3 letters from the
word “DRIVER”?
• In how many ways can a group of 5 members be formed by
selecting 3 boys out of 6 boys and 2 girls out of 5 girls?
Independent events
• Two events are independent if one of the following are
true:
P(A|B) = P(A)
P(B|A) = P(B)
• Two events A and B are independent if the knowledge
that one occurred does not affect the chance the other
occurs. For example, the outcomes of two roles of a fair
die are independent events. The outcome of the first roll
does not change the probability for the outcome of the
second roll. To show two events are independent, you
must show only one of the above conditions. If two events
are NOT independent, then we say that they are
dependent.
Independent event
• Example:
• Let’s assume that the probability of oil prices in
Pakistan rising tomorrow is 0.4 and the probability of
raining in Lahore tomorrow is 0.2.
• Assume that you toss a fair coin six times and get six
heads and no tails. What is the probability that you
will get a heads the seventh time you toss the coin?
Mutually exclusive events
• A and B are mutually exclusive events if they cannot
occur at the same time. Said another way, If A
occurred then B cannot occur and vise-a-versa. This
means that A and B do not share any outcomes and
P(A ∩ B) = 0.
• For example, suppose the sample space S = {1, 2, 3,
4, 5, 6, 7, 8, 9, 10}. Let A = {1, 2, 3, 4, 5}, B = {4, 5, 6,
7, 8}, and C ={7, 9}. A∩B = {4, 5}. P(A∩B)= 2/10 and
is not equal to zero. Therefore, A and B are not
mutually exclusive. A and C do not have any
numbers in common so P(A ∩ C) = 0 . Therefore, A
and C are mutually exclusive.
Mutually exclusive events
Joint, Marginal and Conditional
Probabilities
• Marginal probability: the probability of an event occurring
(p(A)), it may be thought of as an unconditional probability. It is
not conditioned on another event. Example: the probability
that a card drawn is red (p(red) = 0.5). Another example: the
probability that a card drawn is a 4 (p(four)=1/13).
• Joint probability: p(A and B). The probability of event A and
event B occurring. It is the probability of the intersection of two
or more events. The probability of the intersection of A and B
may be written p(A ∩ B). Example: the probability that a card is
a four and red =p(four and red) = 2/52=1/26.
• Conditional probability: p(A|B) is the probability of event A
occurring, given that event B occurs. Example: given that you
drew a red card, what’s the probability that it’s a four (p(four|
red))=2/26=1/13. So out of the 26 red cards (given a red card),
there are two fours so 2/26=1/13.
Conditional probability
• In many probability situations, being able to determine the probability of one event
when another related event is known to have occurred is important. Suppose that
we have an event A with probability P(A) and that we obtain new information or
learn that another event, de- noted B, has occurred. If A is related to B, we will
want to take advantage of this information in computing a new or revised
probability for event A.
• This new probability of event A is written P(A | B). The “|” denotes the fact that we
are considering the probability of event A given the condition that event B has
occurred. Thus, the notation P(A | B) is read “the probability of A given B.”

P(A | B) = P(A ∩ B)/P(B)

P(B | A) = P(A ∩ B)/P(A)
Conditional Probability
Multiplication Rule
• Sometimes we know the conditional probability P(A | B) and we want
to know the joint probability P(AB). We can obtain the joint
probability from the following multiplication rule for probabilities
• Multiplication Rule for Probability. The joint probability of A and B
can be expressed as
P(AB) = P(A | B)P(B)
• Multiplication Rule for Independent Events. When two events are
independent, the joint probability of A and B equals the product of
the individual probabilities of A and B.
P(AB) = P(A)P(B)
Addition Rule
• When we have two events, A and B that we are
interested in, we often want to know the probability that
either A or B occurs. Here the word “or” is inclusive,
meaning that either A or B occurs or that both A and B
occur. Put another way, the probability of A or B is the
probability that at least one of the two events occurs.
Such probabilities are calculated using the addition rule
for probabilities.
• Addition Rule for Probabilities. Given events A and B,
the probability that A or B occurs, or both occur, is equal
to the probability that A occurs, plus the probability that
B occurs, minus the probability that both A and B occur.
P(A or B) = P(A) + P(B) – P(AB)
• If events are mutually exclusive
P(A or B) = P(A) + P(B)
Expected Value
• The expected value of a random variable is the probability-weighted
average of the possible outcomes of the random variable. For a
random variable X, the expected value of X is denoted E(X).
E (X) = P (X1) X1 + P (X2) X2 + … + P (Xn) Xn

Probability EPS ($)

0.15 2.60
0.45 2.45
0.24 2.20
0.16 2.00
1.00
Probability tree
• A way of representing the probabilities of two or more events.
• The first node of the tree represents marginal or unconditional
probability and all the subsequent nodes represent conditional
probabilities.