Which statement best describes the difference between nominal GDP and real GDP?

• A. Nominal GDP adjusts for inflation, while real GDP is measured at current-year prices without any inflation adjustment.
• B. Nominal GDP is measured using current-year prices, while real GDP is measured using prices from a base year (constant prices) to remove the effect of inflation.
• C. Nominal GDP includes only domestically owned production, while real GDP includes all production within a country’s borders.
• D. Nominal GDP measures total output, while real GDP measures total spending, so they are conceptually different aggregates.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the definition of nominal GDP. Nominal GDP is the total market value of all final goods and services produced within a country in a given year, measured using the prices that prevail in that same year (current-year prices).
2. Step 2: Understand the definition of real GDP. Real GDP measures the total output of an economy but adjusts for changes in price level by using prices from a fixed base year (constant prices). This adjustment removes the effect of inflation or deflation.
3. Step 3: Recognize the key difference: nominal GDP can increase either because of higher production or higher prices, while real GDP increases only if there is an increase in actual production, since it holds prices constant.
4. Step 4: Evaluate the given statements by comparing them to these definitions. The correct statement should reflect that nominal GDP uses current-year prices and real GDP uses base-year prices to adjust for inflation.
5. Step 5: Conclude that the statement 'Nominal GDP is measured using current-year prices, while real GDP is measured using prices from a base year (constant prices) to remove the effect of inflation' best describes the difference between nominal and real GDP.