Note. Unity 5 introduced the Standard Shader which replaces this shader.
Like a Diffuse shader, this computes a simple (Lambertian) lighting model. The lighting on the surface decreases as the angle between it and the light decreases. The lighting depends only on the angle, and does not change as the camera moves or rotates around.
Normal mapping simulates small surface details using a texture, instead of spending more polygons to actually carve out details. It does not actually change the shape of the object, but uses a special texture called a Normal Map to achieve this effect. In the normal map, each pixel’s color value represents the angle of the surface normal. Then by using this value instead of the one from geometry, lighting is computed. The normal map effectively overrides the mesh’s geometry when calculating lighting of the object.
You can import normal maps created outside of Unity, or you can import a regular grayscale image and convert it to a Normal Map from within Unity. (This page refers to a legacy shader which has been superseded by the Standard Shader, but you can learn more about how to use Normal Maps in the Standard Shader)
The Normal Map is a tangent space type of normal map. Tangent space is the space that “follows the surface” of the model geometry. In this space, Z always points away from the surface. Tangent space Normal Maps are a bit more expensive than the other “object space” type Normal Maps, but have some advantages:
Diffuse computes a simple (Lambertian) lighting model. The lighting on the surface decreases as the angle between it and the light decreases. The lighting depends only on this angle, and does not change as the camera moves or rotates around.
Generally, this shader is cheap to render. For more details, please view the Shader Peformance page.