POSC 202A: Lecture 5 Today: Expected Value

Expected Value Expected Value- Is the mean outcome of a probability distribution. It is our long run expectation of the expected return of some (social) process.

Expected Value The Law of Large Numbers- If a random phenomenon with numerical outcomes is repeated many times independently, the mean of the actually observed outcomes approaches the expected value.

Expected Value To calculate, we need to know: 1.The benefit from something occurring (B). 2.The probability the benefit occurs (P) 3.The cost (benefit) of something not happening (B c ). 4.The probability this cost does not occur (1-P) Expected Value= (B*P)+ B c *(1-P)

Expected Value Expected Value= (B*P)+ B c *(1-P) In the overwhelming majority of cases B c =0. So, EV reduces to B*P

Expected Value Expected Value- A random phenomenon that has multiple outcomes is found by multiplying each outcome by its probability and adding all of the products.

Expected Value Expected Value= (B*P)+ B c *(1-P) Here we use B to be the net benefit. In the overwhelming majority of cases B c =0. Think of this as the return (profit+investment). So, EV reduces to B*P

Expected Value: Roulette A roulette wheel has 38 slots, numbered 0,00, and are red, 18 are black, and 2 are green. The wheel is balanced so that the ball is equally likely to land on any slot.

Expected Value: Roulette Three main bets: One number: win if the number comes up. One column (or dozen): win if any in the column comes up. One color: win if the color comes up.

Expected Value: Roulette The key probabilities are: One number: 1/38 One column (or dozen): 12/38 Black or Red: 18/38

Expected Value: Roulette The key bets are: One number: returns $36 (win $35) One column (or dozen): returns $3 (Win $2) Black or Red: returns $2 (win $1)

Expected Value: Roulette What are the expected values? (Recall, B*P) One number: One column: One color:

Expected Value: Roulette What are the expected values? Recall, = (B*P)+ B c *(1-P) One number: (1/38 * $35)+(37/38*-$1)= (35/38)-(37/38) = One column: (12/38* $2)+(26/38*$-1)= (24/38)-(26/38) = One color: (18/38* $1)+(20/38*$-1)= (18/38)-(20/38) = What does this mean? Which gives us the best chance of winning money?

Expected Value: Roulette Shortcut method: return for each $1 bet. Recall, B*P One number: 1/38 * $36=.947 One column: 12/38* $3=.947 One color: 18/38* $2=.947 What does this mean? Which gives us the best chance of winning money?

Expected Value: Roulette Which gives us the best chance of winning money? To answer this question we can use what we learned about the normal curve to solve for the areas. How would we do this?

Expected Value: Roulette How would we do this? Convert each bet type to standard units and solve for the area that corresponds to a profit.

Expected Value: Roulette How would we do this? Conceptually, draw and label our curve: $0

Expected Value: Roulette How would we do this? Next put into Standard Units. Recall Or S.D. Clearly, we need to find the SD.

Expected Value: Roulette Clearly, we need to find the SD. We can use the SD formula from last week. But, how do we find observations on which to calculate it?

Expected Value: Roulette The areas (probabilities) from the Z table, differ on each bet:

Recall that underlying distributions converge around the sample mean as the number of trials increase.

Expected Value REMEMBER Expected Value- Is the AVERAGE outcome of a probability distribution. It is our long run expectation of the expected return of some (social) process. The outcome in any particular trial, instance, or case, will vary.