Use the extended AD–AS model to explain how inflation depends on aggregate demand and not the level of real GDP.

What will be an ideal response?

Looking at the AD–AS graph, a shift in long-run AS causes the price level to lower significantly if aggregate demand remains the same, even though output has increased. However, if aggregate demand increases when long-run AS shifts outward, the price level does not decrease significantly, but rather will remain the same, decline slightly, or increase slightly depending on the extent of the shift of aggregate demand relative to aggregate supply. Thus the level of inflation depends on the change in aggregate demand and on a change in aggregate supply.