Back in the 'good old days' of command prompts and 1.2MB floppy disks, programs needed very little RAM to run because the main (and almost universal) operating system was Microsoft DOS and its memory footprint was small. That was truly fortunate because RAM at that time was horrendously expensive. Although it may seem ludicrous, 4MB of RAM was considered then to be an incredible amount of memory.
However when Windows became more and more popular, 4MB was just not enough. Due to its GUI (Graphical User Interface), it had a larger memory footprint than DOS. Thus, more RAM was needed.
Unfortunately, RAM prices did not decrease as fast as RAM requirement had increased. This meant that Windows users had to either fork out a fortune for more RAM or run only simple programs. Neither were attractive options. An alternative method was needed to alleviate this problem.
The solution they came up with was to use some space on the hard disk as extra RAM. Although the hard disk is much slower than RAM, it is also much cheaper and users always have a lot more hard disk space than RAM. So, Windows was designed to create this pseudo-RAM or in Microsoft's terms - Virtual Memory, to make up for the shortfall in RAM when running memory-intensive programs.
How Does It Work?
Virtual memory is created using a special file called a swapfile or paging file.
Whenever the operating system has enough memory, it doesn't usually use virtual memory. But if it runs out of memory, the operating system will page out the least recently used data in the memory to the swapfile in the hard disk. This frees up some memory for your applications. The operating system will continuously do this as more and more data is loaded into the RAM.
However, when any data stored in the swapfile is needed, it is swapped with the least recently used data in the memory. This allows the swapfile to behave like RAM although programs cannot run directly off it. You will also note that because the operating system cannot directly run programs off the swapfile, some programs may not run even with a large swapfile if you have too little RAM.