Slide 7-1

Chapter 7
Random Variables: Working with Uncertain Numbers

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Random Variable
The number is the observation of the random variable The random variable is the meaning of the number
The observed value is 17 for the random variable
Last weeks warranty returns (number of customers)

A specification or description of a numerical result from a random experiment

Examples
Todays stock market close The number of defective parts produced today Next quarters sales

Summaries:
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Q = mean (expected value) W = standard deviation

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Examples of Random Variables

Standard Deviation $0 $0.50 $13.30

Random Variable X = $1.40 Y= Z=

Mean $1.40 $1.50 $1.90

{ {

$1 prob 0.5 $2 prob 0.5

$0 prob 0.98 $95 prob 0.02

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Discrete Random Variable

Can list all possible outcomes Probability Distribution

The list of values and probabilities. Use it to compute!

Mean (expected value) of random variable X Q = Sum of Value v Prob of Value = E(X) = XP(X)
Gives a typical or central value of the random variable

Standard deviation of random variable X

W = Sum of (Value Q)2 v Probability of Value =
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( X  Q ) 2 P( X )

Tells about how far from expected this random variable will be

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Example: Investment Payoffs

Payoff (Value) $0 $95 Probability 0.98 0.02

Probability distribution of investment payoffs

Q = 0 v 0.98 + 95 v 0.02 = $1.90

The expected payoff is $1.90 A compromise between $0 (most of the time) and $95 (rarely)

W = (01.90)2v 0.98 + (951.90)2v 0.02 = $13.30

Actual payoffs approximately $13.30 above or below expected A compromise between being $1.90 below average (most of the time) and $93.10 above average (rarely)
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Slide 7-6 Fig 7.1.1

Example: Profit Scenarios

Scenario Great Good OK Lousy
0.5 0.4 0.3 0.2 0.1 0.0 -5 Probability

Profit ($millions) $10 5 1 4

Good OK Lousy

Probability 0.20 0.40 0.25 0.15

Great

10 Profit ($millions)

Standard deviation: $4.40 million

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Expected profit: $3.65 million

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Binomial Distribution
e.g., Interview 50 random customers
How many like the new product? 0, 1, 2, , 49, or 50

A special type of discrete random variable

e.g., What percent of stocks went up yesterday?

X is binomial if it is the number of occurrences of some event, out of n trials, provided that
The probability T is the same for all trials, and The trials are independent of one another
so that each trial brings new, independent information

Binomial proportion or percent: p = X/n

This is the relative frequency of the event e.g., if X = 35 of n = 50 people like product, p = 35/50 = 0.70
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Binomial Probabilities
0.4

A discrete distribution
Skewed if T is close to 0

T=0.05, n=25
0.2 0 0 0.3 0.2 0.1 0 5 10 15 20 25

T=0.5, n=25

Symmetric if T is 0.5 (or close)

Approximately normal

10

15

20

25

Skewed if T is close to 1

0.3 0.2 0.1 0

T=0.9, n=25

10

15

20

25

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Binomial Mean and Std. Deviation

No need to compute the probability distribution
work directly from n and T

Shortcut to find mean and standard deviation quickly for binomial random variables (X or p)

Number of Occurrences, X Mean Std. Dev. QX = nT WX = nT(1T)

Proportion or Percent, p = X/n Qp = T Wp = T(1T)/n

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Example: Sampling Defective Parts

Number of Defects, X Proportion or Percent Defective, p = X/n Qp = T = 0.07
Expect to see 7% defective, on average

Draw a random sample of n=200 from the days production Suppose that T = 7% of this production is defective

Mean

QX = nT = 200v0.07 = 14
Expect to see 14 defects, on average

Std. Dev.

WX = nT(1T) = 200v0.07v0.93 = 3.61

Typically expect approx. 3.61 more or less than 14

Wp = T(1T)/n = 0.07v0.93/200 = 0.018

Typically expect approx. 1.8% more or less than 7%

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Computing Binomial Probabilities

n a P( X ! a ) ! T (1  T)n  a a n! ! T a (1  T)n  a a!( n  a )! 1 v 2 v 3 v ... v n ! Ta (1  T)n  a [1 v 2 v 3 v ... v a ][1 v 2 v 3 v ... v (n  a )]

Binomial probability that X equals a

Example: probability that exactly a = 2 of your n = 6 major customers will call tomorrow (assuming that T=0.25 is the probability that each one will call)
6 P( X ! 2) ! 0.25 2 (1  0.25 )62 2 ! 15 v 0.0625 v 0.316406 ! 0.297
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Normal Distribution

A special continuous distribution (not discrete) For every mean Q and (positive) standard deviation W there is a normal distribution
The mean Q moves the curve left and right The standard deviation W widens and narrows the curve

W Q
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Probability: Area Under the Curve

More likely Less likely a b a b

Probability of observing a value between a and b is area under the curve

Note: total area = 1

Probability = 0.50

Probability = 0.68 (one std. dev.)

Probability = 0.95 (two std. devs.)

W W Q
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W W Q

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Standard Normal Distribution

Normal with mean Q = 0 and std. deviation W = 1

-3

-2

-1

Standard normal probability table

Gives probability that a standard normal is less than a given value Examples Probability
= 0.3085 -3 -2 -1 0 1 Value = 0.5 2 3 Value 1 0 1 2 Probability 0.1587 0.5 0.8413 0.9772

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Finding Normal Probabilities

Example: Sales are forecast as $80 million (mean) with a standard

deviation of $10 million. Find the probability that sales will exceed $86 million, assuming a normal distribution

Figure out the question

Find Prob(X>86) where Q=80 and W = 10

Standardize (Subtract Q, divide by W to get std. normal)

( W > 8680 ) 10 = Prob ( Standard > 0.60) normal

Prob
XQ

Draw Picture

-3

-2

-1

0 1 0.60

Use tables, find answer: 10.7257 = 0.274

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Normal Approx. to the Binomial

Idea: to make it easier to compute binomial probabilities If

n is large, and T is not too close to 0 or 1,

Then
Binomial probabilities for X are close to normal probabilities with
Q = QX = nT Q = Qp = T
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W = WX = nT(1T) W = Wp = T(1T)/n

Similarly for p=X/n with

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Example: an Opinion Poll

We interview n = 400 chosen at random What are the chances that fewer than 200 will say they approve? That is, find Prob (X < 200)
When you round any number less than 199.5 to the nearest whole number, the result will be fewer than 200 The mean is QX = nT = 400v0.55 = 220 The standard deviation is WX = nT(1T) = 9.9499 We need to compute the probability that a normal random variable with this mean and this standard deviation is less than 199.5 Prob

Suppose T = 55% approve presidents performance

( XQ W

<

199.5220 9.9499

) = Prob ( Standard < 2.06) = 0.020 normal

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Example: Poll (continued)

What are the chances that more than 58% will say they approve?
Convert from percentage p to number of people X Note that 58% of 400 people is 0.58v400 = 232 people Numbers that round to more than 232 are 232.5 and above We need to compute the probability that a normal random variable with mean QX = 220 and standard deviation WX = 9.9499 is more than 232.5

Still assuming 55% approve and we interview 400 at random

Prob

XQX W

>

232.5220 9.9499

) = Prob ( Standard > 1.26 ) = 0.10 normal

About 10% of the time we will find more than 58%

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