Refer back to the table in Figure 12.7 in the previous chapter. Suppose that aggregate demand increases such that the amount of real output demanded rises by $7 billion at each price level. By what percentage will the price level increase? Will this inflation be demand-pull inflation or will it be cost-push inflation? If potential real GDP (that is, full-employment GDP) is $510 billion, what will be the size of the positive GDP gap after the change in aggregate demand? If government wants to use fiscal policy to counter the resulting inflation without changing tax rates, would it increase government spending or decrease it?

Figure 12.7:

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Price level (index numbers) 100 92 AS X AD 502 510 514 Real domestic output, GDP (billions of dollars) Real Output Demanded (Billions) $506 508 510 512 514 Price Level (Index Number) 108 104 100 96 92 Real Output Supplied (Billions) $513 512 510 507 502