Blocking is the use of moisture and/or heat to stretch your project into the desired shape. It's often done with a steam iron, which is what I used to make the shape of the throw pictured below more regular.
Sometimes it's used to make things lie flat that don't want to. For instance, things knitted in stockinette stitch can be blocked to reduce how much the edges roll. In the throw pictures above, several of the cables segments bunch up like ribbing, and blocking the blanket helped flatten them out.
Other times, it's used to stretch a piece into a desired shape. Lace is often blocked to bring the design into focus, make it lie flat, and force the edges into the desired shape. This is done by wetting the piece (with water or with water mixed with starch or glue) and pinning it out on a blocking board into the proper shape.
In the case of the blanket (above) the cable patterns had different gauges from the seed stitch squares, so the different pieces had different widths, despite being the same number of stitches across. Since the yarns I used were all pure wool, I could just lightly steam iron it to flatten out the cable panels and achieve a more regular overall shape. If the yarns had contained any synthetic fibers, I would have been much more careful, using a lower temperature in the iron and possibly even some kind of thing barrier between the iron and the blanket.
Blocking can also be used to help even out irregularities in gauge, which can be visible in fairisle knitting, in pieces made both in rounds and rows, or when the knitter has a different gauge on the knit and purl sides. On sweaters, blocking is often used to flatten out seams.
If I had been doing things properly, I would have blocked the pieces of my blanket before seeing them together, which would have made the finishing work easier.
Garments made from machine washable fibers are often out through the washer and dryer instead of being blocked. Items made from delicate yarns or yarns that are very fuzzy can be harmed from blocking and usually don't need it. Still, knowing how to block is a useful tool in any knitter or crocheter's belt.