A shell is basically a piece of software that is used as an interface for human beings to input text commands to other applications resident on a computer (including parts of the OS core itself).

http://en.wikipedia.org/wiki/Shell_(computing)

It's how you use a computer when you have no graphical desktop and mouse.

Like in the 'good old days' of DOS and CP/M.

Or when you want a really secure system.

Basicaly, the shell is the terminal.

If your looking for the actual inner workings of how a "shell" operates I can't help you.

A Shell takes , "stdin" and processes it. stdin is standard input ie... keyboard or mouse and processes it to either stdout or stderror. standard output (what you see on the screen))