Diminishing Returns

Updated: Oct 25

Summary


Diminishing returns refers to the phenomenon where investing more and more of some resource (such as money or time) produces benefits at a lower and lower rate - and hence becomes less efficient the more one invests. In other words, your first dollar spent on something is often far more useful than your thousandth dollar. This common phenomenon can heavily influence how promising different opportunities can be.


Overview


Diminishing returns is a famous principle in economics describing a common pattern that emerges when we invest increasing amounts into a specific effort. To understand it, let’s look at a simple example.


Imagine that a remote village has no medical professionals, and as a result loses many lives to common curable diseases. If they hired a doctor to move to the village and work there, her work would provide huge health benefits. She’d likely have her hands full, and would need to prioritize the most severe cases first - treating them herself if she can, and directing more complex cases to more established hospitals in other regions. She probably wouldn’t have the capacity to treat many cases - even if they’re still significant to people’s well-being. Eventually, a second doctor is hired and moves to the village. The second doctor they hire is equally talented and professional, and can take on the most important cases the first doctor didn’t have time for. For example, perhaps they treat many major chronic-but-not-life-threatening diseases. The second doctor clearly continues to provide significant benefits to the community - but they still make less of a difference than the first doctor - since the first doctor can already take care of the most critical cases - she can utilize her time most effectively. Even if the two doctors decide to equally distribute severe cases between them, from the village’s point of view - the decision to hire a second doctor (though still a great investment) provides less value than the decision to hire the first doctor. The second doctor still has less marginal impact. This phenomenon will continue if they hire more doctors - each doctor will continue to provide additional benefits, but less than the previous ones. If the village decides to splurge on thousands of doctors, they’ll eventually find many of their doctors sitting around with nothing to do.


This phenomenon is quite common, and applies not only to doctors in remote villages - but to many resources invested in many problems. Perfectionists often hear their friends tout the 80/20 rule - that the first 20% of their effort achieves 80% of the results, while the remaining 80% of their work focus on unimportant minutiae (the remaining 20%). When buying a product, for example a cell phone, the differences between a $20 cell phone and a 120$ cell phone are very important - like whether it is likely to work three months later. But the differences between a $1,000 cell phone and a $1,100 cell phone are usually a couple additional megapixels in your camera that you can’t actually see, and access to technologies no app supports yet. These are all cases of diminishing returns - additional investments are often useful, but less useful than the investments that came before them. One of the reasons this pattern is common is because we often begin by spending our resources on the most promising or efficient things, and then additional resources have to go to next-best investment opportunities.


One famous example of diminishing returns when trying to help others is how donations are used by charities. In many cases, charities can do great work, but might not be able to use large amounts of additional funding as well as they utilize their current budget (this is especially true if they get much more money than they’re used to). That’s why when GiveWell looks for the best donation opportunities, they don’t just look for charities that can use money more efficiently - they look for charities that have significant room for more funding. This means they look for charities that can receive very large additional donations without experiencing significant diminishing returns.


Diminishing returns is one of the reasons that many people take into account neglectedness when trying to prioritize different causes. If we believe that working on most causes will have diminishing returns - then when comparing two equally promising causes, we might be able to make a bigger difference in the cause to which less people have dedicated their careers or money.


It’s important to note that diminishing returns are not a law of nature, and don’t apply in all cases - sometimes the efficiency of investments can increase as we invest more. One effect that can sometimes counteract diminishing returns is economies of scale, where organizations become more efficient the larger their operations become. In these cases, more careful analysis is required to estimate whether future investments will be more or less cost-effective than past ones. However, in cases where we’re simply doing more of the same without building upon previous efforts (for example, founding new organizations that don’t collaborate with existing ones, hiring employees that don’t use a common infrastructure, etc.) - diminishing returns are an incredibly likely outcome.


In conclusion, diminishing returns describe a common relationship between how much we (or others) have invested already, and how much benefit we should expect to see in return. For this reason, understanding diminishing returns can help us in impact evaluation, prioritizing causes, and making impact-focused career decisions.


Additional Resources

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