Avalon is the new rendering and compositing technolgoy that Microsoft is developing primarily for Longhorn (Microsoft's next release of Windows) that is available in beta form on Windows XP as I write this.
From Windows 3.0 all the way through Windows XP, the Windows graphical environment was pretty primitive. The Graphical Device Interface (GDI) provided only limited visual options to developers.
As 3D hardware has improved, the gulf between what developers could do with traditional Windows programs versus what one could see in a PC game grew more and more obvious.
Avalon is designed to bridge that gap. It provides two things of particular interest:
(1) It delivers a new rendering and compositing model that developers can take advantage of. This new model can make use of the latest/greatest advances in video hardware (such as 3D). That doesn't mean one must use it to create "3D" looking programs but rather it means that all kinds of impressive visual effects become possible.
(2) It provides a new programming model that allows software developers to create user interfaces that are defined declaratively (such as created via XAML).
(Editorial on)
Everything else you hear about Longhorn is mostly just fluff. It's really about Avalon. Without Avalon, there's not much point to Longhorn in my view.
The reason for that is not because people want eye candy but because we are currently moving towards a video stand-still.
Consider this, modern LCD displays can display at 1600x1200. But many people don't bother to run at the highest resolution their monitor can display because "everything gets too small". That's because fonts and other elements in Windows are at a static DPI (96 dpi to be precise).
Avalon's compositer allows you to use the full potential of your display. Increase your resolution as much as you can and then adjust the size of everything on the fly. Instead of bitmaps and hard coded font sizes, you have vector based interfaces that simply become more detailed, more defined as you increase the DPI. Same for fonts.
So the user running at say 3200 x 2400 in 2008 isn't greeted with tiny text and tiny UI. Their UI is whatever size that is comfortable for the user with it being sharp and detailed (Rather than scaled up with fuzzyness).
The compositing engine will allow for far for interesting ways to display information on the screen. Right now, developers are limited in how they can display things on screen by the graphics sub-system. When people saw the Dock on MacOS X with its "genie" effect, PC users oohed and awed. That sort of thing is just the tip of the iceberg. That's just eye candy.
With XAML, developers will be able to put together sophisticated, visually appealing programs quickly and easily that tap into Avalon. This could create user interfaces that are designed to meet the user's needs much more easily than what we have today.
(editorial mode off)