It gives readers the ability to view all of your posts on a certain category at once, say, Make-Money Tips or Blogging Tips or whatever you happen to be writing about.
If you have a team blog, you could also give each member their own label, so you could easily read all the posts by any one of them.
You can place single words or longer phases in the box; whatever you choose to write there, should reflect what your post is about. When you publish your post, the labels will be listed with it.
Clicking any of the labels will take you to a page containing only posts with that label. This gives readers an easy way to navigate your blog based on categories.
If you want to display some or all of your labels on the sidebar, you can make use of the Blogger "Labels" gadget.
That's all.
I hope this helps.