A waiter serving dinner slips, and spills gravy on a guest's white silk evening gown. The guest glares at the waiter, and the waiter declares "I'm sorry. It was my fault." Why did the waiter say that he was at fault? He knew that he was at fault, and he knew from the guest's angry expression that she knew he was at fault. However, the sorry waiter wanted assurance that the guest knew that he knew he was at fault. By saying openly that he was at fault, the waiter knew that the guest knew what he wanted her to know, namely, that he knew he was at fault. Note that the waiter's declaration established at least three levels of nested knowledge.
Certain assumptions are implicit in the preceding story. In particular, the waiter must know that the guest knows he has spoken the truth, and that she can draw the desired conclusion from what he says in this context. More fundamentally, the waiter must know that if he announces "It was my fault" to the guest, she will interpret his intended meaning correctly and will infer what his making this announcement ordinarily implies in this context. This in turn implies that the guest must know that if the waiter announces "It was my fault" in this context, then the waiter indeed knows he is at fault. Then on account of his announcement, the waiter knows that the guest knows that he knows he was at fault. The waiter's announcement was meant to generate higher-order levels of knowledge of a fact each already knew.
Extracted from an article on Common Knowledge at http://plato.stanford.edu/entries/common-knowledge/