John
Photoshop is primarily a raster image processing package. That means it
deals with images that are made up of a grid of pixels in pre-defined
brightness and colour values.
However, it can handle vectors too in a limited capacity. This is how it's
able to stretch and scale text up and down without introducing distortion.
It's also how the likes of paths and the pen tool work.
As an extension of this, it now has the ability to handle some vector
graphics in its own right.
Of course, as with everything, you choose the right tool for the right job.
If you're working mostly with vectors, you choose Illustrator.
If you're working mostly with rasters, you choose photoshop.