Archive and Install
Select this option if you want to install a "fresh" system on your computer. This type of installation moves existing System files to a folder named Previous System, then installs a new copy of Mac OS X. You cannot start up your computer using the Previous System folder.
Archive and Install installations require the largest amount of available disk space because you need to have room to preserve your existing System and the new one you are installing. This is a good choice if you've already backed up your important files and are trying to resolve an existing issue. Mac OS X-installed applications, such as Address Book and Safari, are archived, and new versions are installed in the Applications folder. For a list of which files are archived, see this article.
Some applications, plug-ins, and other software may have to be reinstalled after an “Archive and Install.” Fonts that were installed in the Fonts folder in the top-level Library folder can be installed in your new system by copying them from the Previous System folder.
About "Preserve Users and Network Settings"
You'll probably want to select the "Preserve Users and Network Settings" checkbox to import your existing accounts' Home folders, and network settings into the new system. Home folders include things such as:
"Preserve Users and Network Settings" also copies the existing Shared folder in the Users folder to your new system.
Important: Usually it's best to reinstall third-party software after an Archive and Install installation to ensure they work correctly. The "Preserve Users and Network Settings" option leaves non-Apple-installed (third-party) items intact, though they may be moved, depending on their location.
You might wonder "What do I do with the Previous System folder?" It may contain items that you need. To determine this, once you've finished configuring, installing, and updating your applications, you can compare the Previous System to the new System. If there are things in the Previous System folder that aren't in the new System folder, copy them over or reinstall. If you're not sure what some items are (and don't seem to need them), leave them in the Previous System folder. Once you're comfortable that you've got everything you need out of it, you can delete the Previous System folder (or leave it around if you have enough free disk space).
You can’t start up your computer using the Previous System folder, but settings, preference files, fonts, plug-ins, and other items remain available in case you need to access them (which you probably won't, if you use "Preserve Users and Network Settings").