Resolution is the smallest amount of input signal change that a device or sensor can detect. The number of bits used to represent an analog signal determines the resolution of the ADC. You can compare the resolution on a measurement device to the marks on a ruler. The more marks you have, the more precise your measurements. Similarly, the higher the resolution, the higher the number of divisions into which your system can break down the ADC range, and therefore, the smaller the detectable change.
A 3-bit ADC divides the range into 23 or 8 divisions. A binary or digital code between 000 and 111 represents each division. The ADC translates each measurement of the analog signal to one of the digital divisions. The following figure shows a sine wave digital image as obtained by a 3-bit ADC. Clearly, the digital signal does not represent the original signal adequately, because the converter has too few digital divisions to represent the varying voltages of the analog signal. By increasing the resolution to 16 bits, however, the number of divisions of the ADC increases from 8 to 65,536 (216). The ADC now can obtain an extremely accurate representation of the analog signal.