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September 2011

1. Basic concepts of probability Example 1 (Basic probability computations (1)). Let X be a random variable distributed as a normal n(5, 4). Find the probabilities of the following events: (a) P (X 6) (b) P (X > 4) (c) P (|X 5| > 1

Example 2 (Basic probability computations (2)). A mutual fund outperforms the market when the return from holding shares of it is higher than holding a porfolio such as the S&P500 (or CAC40). Consider a ten year period and let the population be the 4,170 mutual funds reported in The Wall Street Journal on January 1, 1995. The performance relative to the market is said random if each fund has a 50-50 chance of outperforming the market in any year and that performance is independent from year to year. (a) If performance relative to the market is really random, what is the probability that any particular fund outperforms the market in all 10 years? (b) Find the probability that at least one fund out of 4,170 funds outperforms the market in all 10 years.

Example 3 (Conditional probabilities computations). Suppose a university admits applicant students based on their score at an entrance exam SCORE, and that university average grade GRADE is related with the entrance exam score by the conditional expectation (GRADE|SCORE) = .70 + .002 SCORE. (a) Find the expected GRADE when SCORE = 800. Find E(GRADE|SCORE = 1, 400). Comment on the dierence. (b) If the average SCORE in the university is 1, 100, what is the average GRADE? (use the law of iterated expectations: E[E(Y |X)] = E(Y ).)

2. Sampling from a normal distribution Example 4 (Student distribution: job training grants and productivity). Holzer, Block, Cheatham, and Knott (1993) studied the eects of job training grants on worker productivity by collecting information on "scrap rates" for a sample of Michigan manufacturing rms receiving job training grants in 1988. The table below lists the scrap rates - measured as number of items per 100 produced that are not usable and therefore need to be scrapped - for 20 rms. Each of these rms received a job training grant in 1988; there were no grants awarded in 1987. Table of data: see Table 1. Find a condence interval for the change in scrap rate from 1987 to 1988 for the population of all manufacturing rms that could have received grants assuming that the change in scrap rates has a normal distribution. (Note: we have assumed that any systematic reduction in scrap rates is due to the job training program.)

3. Large sample results Example 5 (Dictators plebiscite). Suppose that a military dictator in an unnamed country holds a plebiscite (a yes/no vote of condence) and claims that he was supported by 65% of the voters. A human rights group suspects foul play and hires you to test the validity of the dictators claim. You have a budget that allows you to randomly sample 200 voters from the country. (a) Let X the number of yes votes obtained from a random sample of 200 out of the entire population. What is the expected value of X if, in fact, 65% of the voters supported the dictator? (b) What is the standard deviation of X, again assuming that the true fraction voting yes in the plebiscite is 65%? (c) Now, you collect a sample of 200, and you nd that 115 people actually vote yes. Use the CLT to approximate the probability that you would nd 115 or fewer yes votes from a random sample of 200 if, in fact, 65% of the entire population voted yes. (d) How would you explain the relevance of the number in (c)? (Most exercises from Wooldridge.)

Table 1: Scrap rates for 20 rms Firm 1987 1988 Change 1 10 3 -7 2 10 3 -7 3 1 1 0 4 .45 .5 .05 5 1.25 1.54 .29 6 1.3 1.5 .2 7 1.06 .8 -.26 8 3 2 -1 9 8.18 .67 -7.51 10 1.67 1.17 -.5 11 .98 .51 -.47 12 1 .5 -.5 13 .45 .61 .16 14 5.03 6.7 1.67 15 8 4 -4 16 9 7 -2 17 18 19 1 18 .28 .2 -.08 19 7 5 -2 20 3.97 3.83 -.14 Average 4.38 3.23 -1.15

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