Here is what Apple has to say about it. In general, inactive memory isn't quite the same as free memory. The kernel might be using it for disk buffer cache, read-only executable pages (the Mail example from the support page), or the inactive memory might be pages of memory from an existing application process that has not accessed them in a while. If memory demand goes up and the amount of free memory reaches a critical point, some of these inactive memory pages will need to be reclaimed, which means page outs for the inactive pages of existing processes.
Page out activity is a sign that you're edging toward a memory starvation situation, but the definite sign of too little memory is heavy paging activity both in and out while doing your normal work. The system is thrashing at this point; active memory pages are being ejected from main memory and the operating system is wasting considerable time waiting for pages to be read back from disk. When you see this, it's time to buy more RAM.