Drupal's path system gives authors the ability to override the path of an item of content. Whilst the internal path of a page might be "/node/1" the external path can be anything you want, and can be set when editing the item of content.
The addition of the Path Auto module makes this change of path easy for your users by using patterns and automatically generating paths based on the data contained within the content item. You might want to use a path that contains the type of entity being presented, what category it was added to, and even the title of the item of content.
This system creates powerful search engine friendly URLs that can add keywords to the paths that Drupal uses to find content.
When building custom entities there are a few things you need to do in order to add Path Auto functionality. It must contain a 'canonical' link that points to the entity and be a fieldable entity with a field called 'path'.