Obesity is typically associated with elevated levels of free fatty acids (FFAs) and is linked to glucose intolerance and type 2 diabetes. FFAs exert divergent effects on insulin secretion from beta cells: acute exposure to FFAs stimulates insulin secretion, whereas chronic exposure impairs insulin secretion. The G protein-coupled receptor GPR40 is selectively expressed in beta cells and is activated by FFAs. We show here that GPR40 mediates both acute and chronic effects of FFAs on insulin secretion and that GPR40 signaling is linked to impaired glucose homeostasis. GPR40-deficient beta cells secrete less insulin in response to FFAs, and loss of GPR40 protects mice from obesity-induced hyperinsulinemia, hepatic steatosis, hypertriglyceridemia, increased hepatic glucose output, hyperglycemia, and glucose intolerance. Conversely, overexpression of GPR40 in beta cells of mice leads to impaired beta cell function, hypoinsulinemia, and diabetes. These results suggest that GPR40 plays an important role in the chain of events linking obesity and type 2 diabetes.