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This is a social-cognitive skill that relates to the ability to think about your own mental state and the mental states of other people.
It's called a theory because what we believe is going on with other people is just that - a theory.
In our daily interactions with other people, it is important to be able to understand their mental states and to think about how those mental states might influence their actions.
The theory of the mind helps us understand how people think, predict their behavior and solve interpersonal conflicts.
Theory of mind skills tend to improve progressively and sequentially with age.
Theory of mind develops as children gain greater experience with social interactions, by playing, pretending, stories, and relationships with parents.
The focus on irrationality is missing the point. To label delusions as irrational means that all 'normal' cognition is rational, which is not true as our beliefs are disproportionately influenced by multiple factors.
A new theory suggests that we form delusions to help us understand and survive in our social environment. These processes allow us to live and cooperate with people by understanding their intentions.