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

• A. Nominal GDP measures production in quantities, while real GDP measures production in dollars.
• B. Nominal GDP adjusts for inflation, while real GDP is measured using current-year prices.
• C. Nominal GDP includes only domestically owned production, while real GDP includes all production within a country’s borders.
• D. Nominal GDP is measured using current-year prices, while real GDP is measured using constant (base-year) prices to adjust for inflation.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the definition of Nominal GDP. Nominal GDP measures the total market value of all final goods and services produced within a country in a given year, 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 market value of all final goods and services produced within a country, but it uses prices from a fixed base year (constant prices) to remove the effects of inflation.
3. Step 3: Recognize the key difference: Nominal GDP can increase either because of an increase in production or because of rising prices (inflation), whereas Real GDP isolates changes in production by holding prices constant.
4. Step 4: Analyze the incorrect statements: For example, nominal GDP does not measure production in quantities alone; it is measured in dollar terms. Also, nominal GDP does not adjust for inflation, and both nominal and real GDP include production within a country’s borders regardless of ownership.
5. Step 5: Conclude that the best description is that Nominal GDP is measured using current-year prices, while Real GDP is measured using constant (base-year) prices to adjust for inflation, allowing for a more accurate comparison of economic output over time.