A Smart Object is a container-like layer into which you can plop all kinds of stuff like Raw files (Working with Raw Files), vectors (drawings) from programs like Adobe Illustrator (Chapter 13), whole PSD files, and even other layers. Smart Objects are smart because Photoshop remembers the original content and what program created it, which lets you:
Transform or resize without losing quality. Instead of resizing the instance (a copy) of the content that you inserted into your document, Photoshop remembers info about the original, resizes that, and then places that information back into your image (without altering the original file). It doesn't matter whether that original lives elsewhere on your hard drive or right there in your Photoshop document (on another layer, say). In the blink of an eye, Photoshop updates your document with the newly resized content without making it look blocky (so long as you don't exceed the file's original dimensions—unless it's a vector, of course). You can also use the full range of transform tools (The Transformers) on Smart Objects, too.