WMG / Elmo's World

Mr. Noodle does understand what Elmo asks him to do, and is Obfuscating Stupidity.

Think about it. Since he's playing a game with a small child/small children (the audience), he pretends to be The Fool so that the audience can play along and learn more about the topic. This is basically the Doylist explanation, but it also makes sense in context (as that's usually how adults interact with children).