Blocking is the process of wetting the finished knit peices (such as an arm, the front, or the back of a sweater), and coaxing it into the exact dimensions you need. As it dries, the size becomes somewhat permenant, until it is wet again.
Think of it as putting your hair in curlers when damp. When it dries, you can take the curlers out and your hair will stay curly until you wash it again. Blocking is the same process, sans the curlers.
Here is a good article
on blocking and how to block your garments.