According to the "misperception effect" explanation of short-run aggregate supply, firms increase output as the price level rises because they mistake the increase in overall prices for an increase in the relative price of their own output.

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The misperception effect theory of short-run aggregate supply posits that firms increase their output as the overall price level increases because they wrongly interpret the increase in general prices as an increase in the relative price of their own goods and services.

According to the "Misperception Effect" Explanation of Short-Run Aggregate Supply