Have you taken into consideration how your opponent has taken into consideration that you have taken into consideration how they… damn… where was I?

Interesting blogpost on “cognitive hierarchy theory”, which basically seems to involve the empirical examination of how many such steps people use in their actual reasoning when making decisions.

Big surprise: They don’t take it to infinity.

"The cognitive hierarchy theory finds that people only do a few steps of this kind of iterated thinking," [Caltech’s Colin Camerer, Professor of Behavioral Economics] explains. "Usually, it's just one step: I act as if others are unpredictable. But sometimes it's two steps: I act as if others think *I* am unpredictable. You can think of the number of steps a person takes as their strategic IQ. A higher strategic IQ means you are outthinking a lot of other people."

Most of us have a pretty low strategic IQ, but that's to be expected, Camerer notes. To reach a truly high strategic IQ requires either special experience with a particular type of game (such as poker), training, or, in rare cases, special gifts.

Perhaps more interesting to us economists are the implications. The prof says: "We think it means you can fool some of the people some of the time"

That would seem to have “interesting implications” for welfare analysis…. ;-)

On a related note – when I encounter comedy based on this theme I always wonder whether the scriptwriter has studied economics. From the mediocre Ben Stiller comedy “mystery men”:

And the sitcom Friends had this as a central gag to the episode where the friends find out that Monica and Chandler have an affair. You can even get t-shirts with the line “They don't know that we know they know we know.”