Bayes Theorem in the Business World
Across multiple classes, we find ourselves encountering Bayes Theorem. Its application to the world around us helps different individuals and organizations run day to day. As explained in lecture, Bayes Theorem is a model that calculates the conditional probability of an event given an observed outcome. The formula is given below:
where:
A, B = events
P(A|B) = probability of A given B is true
P(B|A) = probability of B given A is true
P(A), P(B) = independent probabilities of A and B
Bayes Theorem is used across multiple fields. For example, Bayes Theorem is used during to the COVID-19 pandemic to calculate the problem someone test positive. During a time of much uncertainty and ambiguity, Bayes Theorem helped provide numbers to explain positive test patterns and calculate likelihoods. We have encountered many in class examples with testing in the medical field. Interestingly enough, Bayes Theorem can also be applied in the business world.
A minor skew in interest rates can impact businesses in many aspects. For example, the article mentions that an unpredicted change in interest rates would impact the rate of the loans that the businesses paying them back. It also affects product exportation that occur overseas as the currency exchange rates would also be affected. This leads to a ripple effect where the supply change would consequently affect our area of the economy as well. The article also mentions that many businesses make predictions on their net income on a reoccurring basis. With many possible events that would lead to profits or losses, these businesses would use probability scenarios that calculate the likelihood of these events occurring.
It has always fascinated me how insurance companies make profit and the reason behind why people would be willing to pay regularly for insurance. Insurance companies run their business on probability. For instance, how likely is a hurricane going to happen in Florida in comparison to New York? All these considerations are taken into account in the business world. Although we live in a world where there is much uncertainty, we are able to use probabilistic models like Bayes Theorem to predict these events.
Link: https://gocardless.com/guides/posts/how-to-use-bayes-theorem-for-business-and-finance/