Google has got in the habit of doing explanatory videos of new products, so I will let them explain it in their own words.
I watched it and had two thoughts, the clever stuff is actually happening in the background, when I think about how the first Oddpost-derived AJAX interface for Yahoo! Mail was comparatively sluggish under load; Google Instant is an extremely impressive combination of coding and infrastructure that competitors will struggle to match.
However since users are used to refining searches as the grey box suggests possible terms; the user experience from the consumer point-of-view is an evolution rather than a revolution.
I think it may take your average consumer a little while to realise just what Google Instant does from a user interface point-of-view and so get the full benefit of refining their intent for the search engine to deliver highly relevant results. This is partly due to the effect that it has on visibility of results ‘above the fold’.
I don’t know how Google Instant will work with advanced search functions yet.