I am not an expert on this but from my understanding the biggest issue, in a nutshell, is that a smaller cache is faster, but a larger cache will take less hits, meaning it is more likely to hold the sought after data. So to improve performance the CPU will go to the smaller faster L1 cache first, if the sought after data isn't there it will then move to the larger relatively slower L2 cache, then to the L3 (if present), then to main system memory, then finally to the HDD if necessary.
So basically there is a balance between smaller and faster, and larger and slower but taking less hits.
There is much more to this though. In fact you could probably write a masters thesis on cache alone.
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