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

• A. Real GDP measures only the production of physical goods, while nominal GDP includes services.
• B. Nominal GDP measures the value of goods and services at current market prices, while real GDP adjusts for changes in the price level using a base year.
• C. Nominal GDP excludes government spending, while real GDP includes it.
• D. Nominal GDP is always higher than real GDP in periods of deflation.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the definitions of nominal GDP and real GDP. Nominal GDP is the total market value of all final goods and services produced within a country in a given period, measured using current prices during the time of measurement.
2. Step 2: Recognize that real GDP adjusts nominal GDP to account for changes in the price level (inflation or deflation) by using prices from a base year. This adjustment allows for comparison of economic output across different time periods without the distortion caused by price changes.
3. Step 3: Note that nominal GDP can increase either because of an increase in production or because of rising prices, while real GDP increases only if there is an actual increase in the quantity of goods and services produced.
4. Step 4: Understand that the key difference is that nominal GDP reflects current market prices, whereas real GDP reflects constant prices from a base year, isolating the effect of price changes.
5. Step 5: Use this understanding to evaluate the given statements and identify the one that correctly describes the difference: nominal GDP measures value at current prices, and real GDP adjusts for price level changes using a base year.