According to the misperception effect, 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 suggests that firms may mistakenly believe that the increase in overall prices is an increase in the relative price of their own output, leading them to increase output in response to a perceived increase in demand. This can result in short-run increases in aggregate supply and output, but may not be sustainable in the long run as prices and costs adjust.

According to the Misperception Effect, Firms Increase Output as the Price