Expected Value

Learning Outcomes

  • Calculate the expected value of an event

Repeating Procedures Over Time

Expected value is perhaps the most useful probability concept we will discuss.  It has many applications, from insurance policies to making financial decisions, and it’s one thing that the casinos and government agencies that run gambling operations and lotteries hope most people never learn about.A roulette wheel

example

In the casino game roulette, a wheel with 38 spaces (18 red, 18 black, and 2 green) is spun. In one possible bet, the player bets $1 on a single number. If that number is spun on the wheel, then they receive $36 (their original $1 + $35). Otherwise, they lose their $1. On average, how much money should a player expect to win or lose if they play this game repeatedly?

 

Expected Value

  • Expected Value is the average gain or loss of an event if the procedure is repeated many times.

We can compute the expected value by multiplying each outcome by the probability of that outcome, then adding up the products.

Try It

You purchase a raffle ticket to help out a charity. The raffle ticket costs $5. The charity is selling 2000 tickets. One of them will be drawn and the person holding the ticket will be given a prize worth $4000. Compute the expected value for this raffle.

Example

In a certain state’s lottery, 48 balls numbered 1 through 48 are placed in a machine and six of them are drawn at random. If the six numbers drawn match the numbers that a player had chosen, the player wins $1,000,000. If they match 5 numbers, then win $1,000.   It costs $1 to buy a ticket. Find the expected value.

View more about the expected value examples in the following video.

Try It

In general, if the expected value of a game is negative, it is not a good idea to play the game, since on average you will lose money.  It would be better to play a game with a positive expected value (good luck trying to find one!), although keep in mind that even if the average winnings are positive it could be the case that most people lose money and one very fortunate individual wins a great deal of money.  If the expected value of a game is 0, we call it a fair game, since neither side has an advantage.

Try It

A friend offers to play a game, in which you roll 3 standard 6-sided dice. If all the dice roll different values, you give him $1. If any two dice match values, you get $2. What is the expected value of this game? Would you play?

Expected value also has applications outside of gambling. Expected value is very common in making insurance decisions.

Example

A 40-year-old man in the U.S. has a 0.242% risk of dying during the next year.[1] An insurance company charges $275 for a life-insurance policy that pays a $100,000 death benefit. What is the expected value for the person buying the insurance?

The insurance applications of expected value are detailed in the following video.

Not surprisingly, the expected value is negative; the insurance company can only afford to offer policies if they, on average, make money on each policy. They can afford to pay out the occasional benefit because they offer enough policies that those benefit payouts are balanced by the rest of the insured people.

For people buying the insurance, there is a negative expected value, but there is a security that comes from insurance that is worth that cost.

  1. According to the estimator at http://www.numericalexample.com/index.php?view=article&id=91 ↵