What is the difference between "had had" and "had" in this context?
1 She woke up screaming because she had had a bad dream.
2 She woke up screaming because she had a bad dream.
If both are wrong, then what is the difference between 1 and 2?
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The verb here is "to have". The simple past tense of "to have" is "had". The past perfect tense of "to have" is "had had". So one of these sentences is using the simple past tense and the other is using the past perfect tense.
The past perfect is generally used to indicate some past event happened before some other past event (so in this case, it indicates that having the bad dream happened before she woke up).
The simple past just says something happened in the past, but doesn't say anything about when it happened relative to other events. However, in this case, the use of "because" already explicitly says that one was the cause of the other, and therefore the bad dream must have happened first, so in this case using simple past has basically the same meaning as using the past perfect.