Final answer:
The statement is false. The firm cannot avoid fixed costs by dropping a product; fixed costs remain regardless of production decisions. Economic decisions should be based on understanding marginal costs vs marginal revenue and price relative to average variable costs.
Step-by-step explanation:
If by dropping a product a firm can avoid more in fixed costs than it loses in contribution margin, the statement is false. Fixed costs do not change with the level of production or whether a product is dropped. They are costs that the firm must pay regardless of its production decisions, such as rent, salaries, and insurance. The variable costs are the ones that change with production levels and can be avoided if a product is dropped.
When making production decisions, a firm should consider the contribution margin, which is the revenue from a product minus its variable costs. If the firm is producing at a quantity where marginal costs exceed marginal revenue (MR < MC), then each additional unit is costing more than the revenue it brings in. In this scenario, the firm would benefit economically by reducing the quantity of output until MR = MC.
Furthermore, if the price falls below average variable cost (AVC), the firm will not be able to cover its variable costs with revenues. In such a case, it would be economically better off shutting down and producing no output, thus only incurring fixed costs, rather than continuing production and losing both fixed and variable costs.
Therefore, even if a product's elimination could theoretically avoid fixed costs, in practice, the organization should focus on the relation of marginal costs to marginal revenue and average variable cost when deciding to continue or drop a product.