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Many games have tried for more "realistic" simulated NPCs, but usually it turns out they don't make the game any more fun, quite the opposite.
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The cost benefit is really poor, but I also wonder if it's just never been done well.

Old text adventures honestly did this heaps better than modern games do, but the reality is there was a more finite action space for them and it wasn't surprising when something wasn't catered for.

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Which games are these? I’d be interested in checking them out.

I’m only aware of experimentation in making more “difficult” NPC AI which was found less enjoyable for obvious reasons, so would be interested to see why similar but different attempts down another path also failed.

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Kingdom Come Deliverance 2 is one of the closer attempts, NPCs will react to lots of things about you and behavior, like if you smell bad or stare at them for too long
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I was so surprised in BotW and TotK to see NPCs duck, huddle, gasp and otherwise react to odd shit you might be doing. Also in dialogue, do contextual things like talk about the weather and time.

I would love to see a Zelda game implement LLM dialogue for random inconsequential dialogue or relating dialogue to the game context.

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