The basic idea behind lawn aeration is that your lawn and the soil beneath it need to breathe. It also breaks up compacted soil, allowing water and fertilizer to permeate into the root zone. Grassy areas prone to high foot traffic (or, worse, car traffic) require lawn aeration more frequently than do other less traffic areas.
Lawn thatch is the layer of mainly dead grass lying between the vegetation of the grass above and the root system and soil below. This layer, if it becomes too thick (1/2 inch or more), can be bad for your grass, as it keeps water and nutrients from seeping down to grassroots.