In the most basic sense:
1. Google assigns PR to some trustworthy sites.
2. When those sites link to others, PR is passed on.
This is roughly how PR gets passed on:
PR4 = 10PR3 = 100PR2 = 1000PR1
So if a page with PR4 has 10 links, each page linked receives PR3.
Note: in reality it's much more complicated.