Closely related to the pari-mutuel system, a Keynesian beauty contest is a concept used to describe an action that is based not on one’s own perception but an inference of what one thinks the public perception will be of a subject. This can be carried one step further to take into account the fact that other entrants would each have their own opinion of what public perceptions are. Thus, the strategy can be extended to the next order and the next, and so on, at each level attempting to predict the eventual outcome of the process based on the reasoning of other rational agents.
To demonstrate this, John Maynard Keynes used an analogy based on a fictional newspaper contest in which contestants were asked to choose the six most attractive faces from a hundred photographs. Those who picked the most popular faces would win a prize.
Keynes then argued: It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth, and higher degrees.
Primary origin: John Maynard Keynes