The object is sought in the project as given above. If it is not found in there, the ITP/MDK Repository will also look for the object in the Libraries configured for that project. These Libraries are configured with the include paths, and are visited in the order given there. When looking in a library, the search path configured for that library is used.
Starting with ITP/MDK Repository 3.5.3, the option "Allow selection of folders in libraries" is present to change the library search path behavior. This option will cause the ITP/MDK Repository to skip the search paths in the library when looking for dynamic objects. Instead, it allows you to include folders of libraries in the search path of the project itself. This way, it is possible to better control the order of places where dynamic objects are sought.