Funding a charity increases the amount of useful work it can do—this is a social return on the money donated. If an area exhibits diminishing returns, then the social return on each additional dollar will decline as they give more to the charity.
The monetary difference between giving nothing and giving $500,000 is obviously the same as the monetary difference between giving $4.5m and giving $5m. However, the theory of diminishing marginal returns suggests that in terms of the amount of good done, the difference between giving nothing and giving $500,000 is probably bigger than the difference between giving $4.5m and $5m. So if there are diminishing marginal returns, a person or organization will get more good done with their first few dollars than with their last ones.
This point does not only apply to organizations like charities and resources like money: it can also apply to for-profit organizations, and resources like time and labour. However, it is unclear to what extent diminishing returns apply in different areas. Owen Cotton-Barratt (2015) gives an overview of the variety of cases it seems to apply to. However, Michael Dickens (2016), for instance, argues that there are no detectable diminishing marginal returns in animal advocacy or work on existential risk.
If charities face diminishing marginal returns, it may make sense to only fund them to a certain level: beyond that we say they have no additional room for more funding. Given that organizations and areas may face different returns to additional labour than they do to additional capital, it is worth considering whether they are more talent- or funding- constrained.
Cotton-Barratt, Owen. 2015. The law of logarithmic returns.
Discusses cases with diminishing marginal returns.
Dickens, Michael. 2016. How should a large donor prioritize cause areas?
Argues that there are no detectable diminishing returns in animal advocacy or existential risk.