Answers
a. Initially the price level is 100. Now with increase the AD, the new price level is 112 at which Real GDP demanded = Real GDP supplied = 513. Hence price rises by (112 - 100)*100/100 = 12%.
This inflation will be demand-pull inflation since AD has increased by $7 billion at each price.
b. If potential real GDP is $510 billion, the current GDP is 513 billion and so there is an inflationary gap of $3 billion.
c.
If government wants to use fiscal policy, it has to decrease the government spending to discourage aggregate spending and eliminate the GDP gap.
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