Lossy == picture is encoded (or "compressed" -- same thing, but Joe Average understands compression better, even that in video world the correct term is encoded) by using a method which gets rid of ""useless"" video details. Basically the whole process is made by fooling your eye/brain and dropping details that you wont normally recognize. Then, by using heavier lossy compression (i.e. lower bitrate in DivX encoding), your eye starts noticing more and more of those details that codec has removed from the video. And these removed parts are removed forever and can't be brought back. Same obviously applies to all encoding -- lossy compression formats are used in pictures, audio and video. Best way to understand the whole process is to test it: take a video clip, short one, with excellent quality. Encode it with DivX or SVCD to certain, relatively good bitrate. Then take the COMPRESSED video again and encode it AGAIN with SAME bitrate. And then take the result from this and encode it AGAIN with SAME bitrate, etc... The bitrate stays the same, but quality gets worse and worse.
Lossless == compares to data compression methods, like ZIP -- you can't expect anyone to compress a Word document by dropping word here and there occassionally, can you? So, lossless compression uses certain methods to compress the video (or audio, if you prefer) WITHOUT dropping any of the details. This is achieved by using certain mathematical formulas to compress data that occurs in the file more than once.
Lossy compression formats include: DivX, MP3, WMA, WMV, DVD/SVCD/MPEG-2 (yes, even DVD is encoded using lossy compression, but in so high bitrate that it looks nice), VCD/MPEG-1, OGG, JPEG, GIF, XviD, etc..
Lossless compression formats include: Musepack, Huffyuv, BMP, PCM (often referred as WAV, but it's not), etc..
Musepack is NOT LOSSLESS, but a very high quality codec, partially based on MPEG1-Layer2 (MP2). Musepacks quality however is often referred as 'perfect' to a humar ear.
dRD did a whole lot of explaining there. I will try to summarize.
A LOSSLESS encoded file contains every bit of the original file, and when unpacked the 100% of the original data is restored. After decopression the data still is 1:1 with the original. File compressors such as ZIP and RAR are examples of this. Lossless audio comression typically saves 50-30% in filesize used.
A lossy compression format will reduce the amount of information. It will try to cut out information which is not necessary for the human instincs. Picture format JPEG, video format DIVX or audio format MP3 are good examples. File size is small but information (QUALITY) is lost.
