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

• A. Nominal GDP values output using current-year prices, while real GDP values output using constant (base-year) prices to remove the effects of inflation.
• B. Nominal GDP includes only goods and services produced domestically, while real GDP includes both domestic and foreign production by domestic firms.
• C. Nominal GDP is adjusted for changes in the quality of goods and services, while real GDP is not adjusted for quality changes.
• D. Nominal GDP subtracts depreciation from production, while real GDP does not subtract depreciation.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the definition of nominal GDP. Nominal GDP measures the total 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 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 purpose of using real GDP. By using constant prices, real GDP allows us to compare economic output across different years without the distortion caused by changes in price levels (inflation or deflation).
4. Step 4: Compare the other statements to the correct definition. For example, nominal GDP and real GDP both include only domestic production, neither adjusts for quality changes directly, and neither subtracts depreciation (that would be Net Domestic Product).
5. Step 5: Conclude that the key difference is that nominal GDP uses current-year prices, while real GDP uses base-year prices to account for inflation, making the first statement the best description.