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

• A. Nominal GDP values production using current-year prices, while real GDP values production using constant (base-year) prices to remove the effect of inflation.
• B. Nominal GDP measures output at market prices, while real GDP measures output at factor cost by excluding depreciation and indirect taxes.
• C. Nominal GDP includes only domestically owned production, while real GDP includes all production within a country’s borders.
• D. Nominal GDP adjusts for inflation using base-year prices, while real GDP uses current-year prices.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the definition of Nominal GDP. Nominal GDP measures the total value of all goods and services produced in an economy using the prices that are current in the year the output is produced. This means it reflects both changes in quantities produced and changes in prices (inflation or deflation).
2. Step 2: Understand the definition of Real GDP. Real GDP measures the total value of all goods and services produced in an economy but uses constant prices from a base year. This adjustment removes the effect of inflation, allowing us to compare output across different years more accurately.
3. Step 3: Recognize the key difference. The main difference is that Nominal GDP uses current-year prices, so it can be influenced by changes in price levels, while Real GDP uses base-year prices to isolate changes in the quantity of goods and services produced.
4. Step 4: Evaluate the given statements by comparing them to these definitions. The correct statement should highlight that Nominal GDP values production at current-year prices and Real GDP values production at constant (base-year) prices to remove inflation effects.
5. Step 5: Conclude that the statement "Nominal GDP values production using current-year prices, while real GDP values production using constant (base-year) prices to remove the effect of inflation" best describes the difference between Nominal and Real GDP.