The revenue department of a state government employs certified public accountant

Question

The revenue department of a state government employs certified public accountants (CPAs) to audit corporate tax returns and book keepers to audit individual returns.

CPAs are paid $31,200 per year, while the annual salary of a bookkeeper is $18,200. Given the current staff of CPAs and bookkeepers, a study made by the department's economist shows that adding one year of a CPA's time to audit corporate returns results in an additional tax collection of $52,000.

In contrast, an additional bookkeeper adds $41,600 per year in additional tax revenue. a. If the department's objective is to maximize tax revenue collected, is the present mix of CPAs and bookkeepers optimal?

Explain. b. If the present mix of CPAs and bookkeepers is no optimal, explain what re-allocation should be made. This is, should the department hire more CPAs and fewer bookkeepers or vice versa?

Explanation / Answer

A) Revenue per cost for CPA = 52000/31200 = $1.67

Revenue per cost for bookkeeper = 41600/18200 = $2.29

Since the revenue per cost for the two is not equal, this is not an optimal mix.

B) In order to reach optimality, the firm must hire more bookkeepers, since net revenue brought in by a bookkeeper is greater than that brought by CPA.

At the optimal point, the two must be equal.

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