There are two places where difficulty levels are set. One is on the Game Options Menu:
That relates to the difficulty of the campaign, basically giving the enemy players more units and stuff like that to make the campaign more challenging.
The other is on the game player set-up screens, and relate to the AI players in the game:
The Easy, Medium and Hard settings rely on the AI script itself to decide how to be less or more difficult. For example, NullBot will not attack in groups on Easy setting, and it will use research adaptation if it's on the Hard setting.
The Insane setting, however, makes a big difference to AI players:
1. It doubles their oil production - you can imagine how much of an advantage that is!
2. It removes fewer map-defined buildings for the AI player (detailed info here
Hope that helps
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