Which of the following best explains the difference between nominal GDP and real GDP?

• A. Nominal GDP excludes government spending, while real GDP includes it.
• B. Nominal GDP measures the value of goods and services at current market prices, while real GDP measures the value at constant prices, adjusting for inflation.
• C. Nominal GDP measures only physical goods, while real GDP includes both goods and services.
• D. Nominal GDP is always higher than real GDP regardless of inflation.

Answer: (B)

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 period, using current prices during the time of measurement.
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 in a given period, but it uses constant prices from a base year to adjust for inflation.
3. Step 3: Recognize that the key difference lies in the price basis: Nominal GDP uses current prices, which can be affected by inflation or deflation, while Real GDP uses constant prices to remove the effect of price changes over time.
4. Step 4: Analyze the options given in the problem by comparing them to these definitions. For example, the option stating that Nominal GDP excludes government spending is incorrect because government spending is included in both Nominal and Real GDP calculations.
5. Step 5: Conclude that the correct explanation is that Nominal GDP measures value at current market prices, while Real GDP measures value at constant prices, adjusting for inflation, which allows for a more accurate comparison of economic output over time.