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In a nutshell, this is how pagerank works:
Popular website with lots of inbound links get high pagerank reflecting their popularity. For each site they link to, they give away a small portion of their pagerank.
All of the websites linking to you give you a small part of their pagerank, and this is how you get your pagerank. You in turn give away a little pagerank when you link to another website, unless you use rel="nofollow"
It's slightly more complicated than that, but that's a basic description.
From Google:
Q: What types of links should get this attribute?
A: We encourage you to use the rel="nofollow" attribute anywhere that users can add links by themselves, including within comments, trackbacks, and referrer lists. Comment areas receive the most attention, but securing every location where someone can add a link is the way to keep spammers at bay.
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