Final answer:
A low CM ratio means that each sales dollar contributes less to covering fixed costs and profits compared to a high CM ratio; thus, for a given increase in sales, profits will increase less with a low CM ratio. Option A is correct answer.
Step-by-step explanation:
For a given increase in sales dollars, a low contribution margin (CM) ratio will indeed result in a lower increase in profits than will a high CM ratio. The CM ratio is the percentage of each sales dollar that contributes to covering fixed costs and generating profit. A higher CM ratio indicates that a larger portion of revenue is available to cover fixed costs and contribute to profits, while a lower CM ratio means less of each dollar of sales contributes to profits.
When prices are high, total revenue is high for each unit sold, increasing the CM and potential profits. Conversely, when prices drop too low, the firm's total revenue line may fall below the total cost curve, resulting in losses at every level of output. In such situations, a profit-maximizing firm will look to produce at the quantity where total revenues are closest to total costs, minimizing losses. Furthermore, if marginal costs exceed marginal revenue (MR), the firm is advised to reduce output until MR equals marginal cost (MC), which is the profit-maximizing condition according to economic theory.
Therefore, firms with a high CM ratio are better placed to increase profits with an increase in sales because a greater proportion of each additional dollar earned from sales contributes to the bottom line. This is in contrast to firms with a low CM ratio, where each additional dollar of sales contributes less to profits, thereby requiring a larger increase in sales to achieve the same increase in profits as a firm with a high CM ratio.
The correct answer to the question: True.