The One With The Dollhouse - S3-E20
Other mistake: The dollhouse is only partially burned when Ross takes it into the bathroom to extinguish it. When he shows it to Phoebe it's completely blackened and destroyed. He and Monica wouldn't have just let it burn; they would have extinguished it ASAP, and there's no reason why that wouldn't have been fast if they doused it in the shower.
Answer: Usually by the seventh night of Hanukkah you don't know what to get the other person, and you will probably resort to getting the other person something insignificant. Chandler is basically saying that the pen is a stupid gift.