The following is based on a workshop given to RWA Chapter Leaders at this year’s national conference in New York.
Take action
Adjust Beliefs
Draw conclusions
Make assumptions
Add meaning
Filter input
Observe stimuli
Human perception functions like a ladder:
Observe stimuli—We are bombarded by millions of stimuli—sights, sounds, smells, tastes, touches—at any given moment.
But the human brain possesses the bandwidth to process only about five to nine pieces of data at any given moment. This forces us to filter out the extra stuff, keeping only the 5-9 bits we believe, based on our current interests and priorities, to be useful.
Then, based on past experience, we add meaning to the observations we decided were worth keeping.
Next, again based on past experience, we make assumptions about what we’ve perceived.
Then we draw conclusions.
Then we adjust our existing beliefs to take into account this new data we’ve experienced.
Finally, we take action based on the perception arrived at in the previous step.
Much of this processing takes place in the basal ganglia–an older part of the human brain that has evolved to process information swiftly, based on past experience. The basal ganglia is very efficient and requires minimal energy to do its job.
As we reach the top of the ladder, though, there’s an opportunity to re-inspect and rethink our conclusions using our pre-frontal cortexes, a more recently-developed part of the brain that’s designed to handle new and unique situations. The pre-frontal cortex requires a lot more energy to do its work, which is why solving complex problems (or developing plots!) is so exhausting.
As you can imagine, there’s a lot of room along this ladder for things to go awry, causing us to react in a less than optimum manner.
There’s a great video on YouTube on this Ladder of Inference.
I suspect that Add Meaning is where the conflict lies in most stories. It seems to provide a whole lot of opportunity for a character to completely misjudge what another character is doing, based on their own back story.
This happens a lot in my demon books. Demons have witnessed Bad Behavior from humans (and Satan) for so many millennia they tend to always assume the worst.
Eight Ladies Writing 
Oh! In my work, there’s a lot of talk about “magic seven” — the number of vocab a student can keep in their head at a given moment — plus two if they are easy words (already learned, or Japanese cognates), minus two if they are more difficult.
I have never thought about applying this to fiction, but it’s true! How many things can a person be expected to remember about the past plot? It might be around seven — Lord Donkeyears is 1) the secret lover of Lady Gumdrops, 2) has a daughter who 3) is campaigning to marry Lord Gumdrops eldest son who 4) may be Lord Donkeyears’ son, as well, and 5) handsome Thom Smith Esq. could be persuaded to court Donkeyears’s daughter if he wasn’t 6) in love with Gumdrops eldest son.
Add two more plot elements to that, and you’ll have to add a diagram to the page, I think.
I believe that some people manage (with practice) to lump a lot of information into one lump, and they somehow manage to juggle seven lumps that would add up to 49 different little lumps to us lesser mortals . . . .
I’ve got too much information to put into place; I think that’s my problem. I need to learn to lump them together more efficiently.
There’s a “magic seven” for vocabulary words? Interesting! I used to work with a guy who was okay in his job as long as he needed to remember no more than 10 things/requirements. As soon as a task was added to his job, he consistently forgot to do well or at all something he’d been doing satisfactorily up until then. We could never figure that out, but it was certainly career-limiting for him.