A Codec (a portmanteau of either COder-DECoder or COmpressor-DECompressor) is information use in the manipulation of data streams. The two main forms of Codecs are video Codecs and audio Codecs and both perform similar duties and indeed are usually used in tandem (as most video has sound). In practise you will use Codecs when encoding video or music for distribution and when playing back video or audio. Codecs are either lossy or lossless, lossless Codecs will have the best playback but lossy Codecs aim to provide high quality playback with a significantly reduced file size.
The workings of an audio codec are incredibly complex but to get a vague idea of the kind of settings involved you can consider PCM (Pulse-code modulation) sampling, PCM is the basis for nearly all computer audio and a large number of other forms of audio transmission. In PCM the audio stream is represented by plotting the path of the sound wave. This is done by plotting the amplitude of the wave at a set interval of time, the quality of the sample is determined by the number of points measured on axis representing amplitude and the number of times the wave is sampled per second, it is important to note that the Nyquist-Shannon sampling theorem plays an important part in determining the minimum number of samples needed to prevent undersampling.
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