Diffraction - the point at which the properties of the Universe (Laws of physics) render our efforts to increase resolution fruitless. Any system manipulating waves such as visible light, x-rays, or electrons, will ultimately be diffraction limited. The Wikipedia entry for diffraction is 'illuminating'. For camera lenses I would also recommend:
My own experience in microscopy was that every day was diffraction limited when the quality of the optics, the object, and the lighting conditions were high enough.
In camera lenses diffraction occurs when the light waves go past an edge. This edge is the blades of the diaphragm. The effect on resolution is dependent on the diameter of the hole formed by the edge. See the Wikipedia article for the mathematics. The loss of resolution will not be seen if other aberrations are greater. The loss of resolution will be obscured if the resolution of the recording medium is lower than the change caused.
So with the best lenses and the best high definition film or digital sensor, will resolution be diffraction limited? Of course. It has been for years! Or rather for ever, but camera lenses are just late arrivals.
It was a major factor in my work photographing fabric weaves and fibres in close-up. Technical Pan film rated at 1/4 ASA, and Nikkor 55 mm f2.8 Micro and 105 mm f4 Micro were our standard tools. With any three dimensional weave depth of focus at smaller apertures had to be balanced against loss of resolution to obtain the most detailed pictures. f 8 was the 'normal' setting, f 5.6 preferred, and f 11 only used in desperation. That was over 25 years ago.
Today with a Nikon D800E and the best lenses such as the two above, or modern Nikkor Micro lenses, or Zeiss Makro lenses, the resolution of the recording system reveals more than even the Technical Pan film could. Thus diffraction is more frequently limiting. To avoid it I do not go below f 5.6. However as ever resolution may have to be sacrificed to depth of focus. A less good lens with optical aberrations, focus shift if not using LV, mirror vibration, etc etc all remove resolution so diffraction only becomes limiting at smaller apertures.
Thus downsampling, because it reduces resolution, will mean diffraction becomes limiting at a smaller aperture. It is still there but the resolution has already been thrown away. I was content at about one stop smaller on a D3X than on the D800E, and two stops smaller on a D2X.
Bring on the 60 MP FX camera on which nothing less than f 4 is acceptable to the resolution freaks!