Sometimes, investing more and more of a resource (such as money or time) ends up producing benefits at a lower and lower rate. And often, the first dollar you spend on something is far more useful than the thousandth dollar. This common phenomenon is known as diminishing returns, and it can have a major influence on how promising different opportunities can be.
When does this come up?
For a moment, imagine a remote village with no medical professionals. Every year the village loses dozens of lives to common curable diseases. When the village hires a doctor to come work there, the doctor’s work provides tremendous health benefits to the community. But with limited time and resources, she can only prioritize the most severe cases – even though the slightly less severe cases still significantly affect people’s well-being.
Eventually the village decides to hire a second, equally talented doctor. He is able to take on the major non-life-threatening diseases that the first doctor didn’t have time for. Although his efforts provide immense benefits to the village, his overall impact is slightly less than that of the first doctor, who continues to spend all her time on the most extreme and pressing cases.
Even if the two doctors equally distribute all the cases between them, it wouldn’t make much of a difference in terms of community benefit. From the village’s point of view, the decision to hire a second doctor provides slightly less value than the decision to hire the first doctor. As the village hires more doctors, each new doctor will continue to provide additional benefits, but slightly less benefits than the previous ones. And 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 known as diminishing returns, a famous principle in economics describing a common pattern that emerges when investing more resources in something causes those resources to be spent less efficiently.
Additional investments
There are many different contexts in which diminishing returns comes into play. For example, you might have heard of the 80/20 rule — that is, the first 20% of effort achieves 80% of the results while the remaining 80% of work focuses on less important minutiae. Diminishing returns also emerges when comparing product prices.
The differences between a $20 phone and a $120 phone, for example, are very important, like whether the phone is likely to work in three months. But the differences between a $1,000 phone and a $1,100 phone are usually a couple additional megapixels in your camera that you can’t actually see. In this case, the additional investments are useful, but less useful than the investments that came before them.
Neglected charities and causes
This same sort of thinking also applies to helping others. In many cases, charities 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). This explains why charity evaluator GiveWell doesn’t just look for charities that can use money more efficiently; they look for charities that have significant room for more funding. In other words, they prioritize charities that can receive large additional donations without experiencing significant diminishing returns.
This also explains why people take neglectedness into account when trying to prioritize different causes. If working on most causes will have some diminishing returns, then we might be able to make a bigger difference in the more neglected cause in which fewer people have dedicated their careers or money (if the two are equally promising).
Exceptions
As these cases illustrate, diminishing returns can have a significant effect on our decision-making and prioritization. However, it’s important to keep in mind that this phenomenon doesn’t apply in all cases. 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, careful analysis is required to estimate whether future investments will be more or less cost-effective than past ones.
Additional resources
- GiveWell – Room for More Funding
- Diminishing returns – EA Forum
- Prospecting for Gold
- Defining returns functions and funding gaps
- Selecting the appropriate model for diminishing returns
Related topics
