Probability


In general, decisions are made under conditions of uncertainty. We make
reference to this by saying that there is a likelihood that a particular event
will take place. In other words we say that there is some numeric measure of
that chance, called probability.

In decision making probability provides a measure of uncertainty associated
with future events.

In real life we have outcomes or events that might involve some type of
experimentation. For instance, telephone calls to test the acceptance of a
certain product. The question is how to assign the probability of buying the
product.

There are three methods for assigning probabilities based on the problem at
hand:

1. Classical method. Equally likely outcomes are assigned probabilities
such that the following two conditions hold

   a. Probability(outcome i) must be nonnegative and less than 1.

   b. The sum of the probabilities of all possible outcomes equals 1.


This method is useful for equally likely outcomes (originally developed for
gambling problems).


2. Relative frequency method. Based on the outcomes of the experiment an
event that occurred more often will carry a higher probability.


3. Subjective method. Probabilities here are assigned based only on the degree
of belief that the event will occur.




Reference:

Anderson, D.R., D.J. Sweeny, and T.A. Williams (1999):  Statistics for
Business and Economics. South--Western.