Q: Can i use itunes or apple app store gift card to do in-app purchases as a substitute for credit card?

You can redeem iTunes or App Store gift cards onto your account (you can't use Apple Store gift cards in iTunes, then can only be used in Apple shops and their online store).

Redeeming a gift card : Redeeming iTunes Gift Cards and content codes

As long as the app was downloaded by the account that you redeem the card onto, and you are logged into that account on your device, then the price of the in-app purchase should automatically be deducted from your account's balance.

How purchases are billed : http://support.apple.com/kb/HT5582

When making purchases, content credits are used first, followed by Gift Certificate, iTunes Card, or Allowance Account credits; your credit card or PayPal account is then charged for any remaining balance.

iTunes and App Store gift cards are basically the same thing, both are redeemed onto your iTunes account and can be used to buy from the iTunes store, app store, Mac app store on Mac computers and the iBookstore - the cards that you shouldn't buy are Apple Store gift cards, they cannot be used with an iTunes account.

When you've redeemed it onto your account then your balance should show in both the iTunes and App Store apps on your iPad, and your computer's iTunes. On my iPad it shows at the bottom of the Featured tab in the App Store app under my account id and at the bottom of the Music tab in the iTunes store app (or you can view your account via Settings > iTunes & App Store and it should show on the screen that you are taken to). On my computer's iTunes it shows at the top left of the store's pages next to my id, and by logging in to view my account via the Store > View Account menu option.

If you are trying to download a paid-for item and you don't currently have a balance or other payment method on your account then you will be taken to the payment details screen so that you can either redeem a gift card or enter one of the other payment methods.

To redeem a card onto your account you can use the Redeem button at the bottom of the Featured tab in the App Store app, or the Music tab in the iTunes store app, on your iPad. Or you can do it via your computer's iTunes, either via the right-hand side of the iTunes store homepage

Or by logging into your account via the Store > View Account menu option and selecting the payment details link on your account

Have you redeemed the card onto your account ? If you exit from that popup you will see a number of buttons on the screen :

It will automatically deduct the item's price from your account's balance