Interpolation is a technique used in image resizing, zooming, shrinking, rotating, and geometric corrections. It works by using known pixel data to estimate values at unknown points. There are different types of interpolation including nearest neighbor, bilinear, and bicubic. Nearest neighbor considers only the closest pixel, while bilinear takes the average of the closest 2x2 pixels. Bicubic interpolation provides the sharpest results as it averages over the closest 4x4 pixels.