All modern video formats use so-called "lossy" compression, meaning that you can sacrifice image quality to reduce the file size. Many image formats do the same thing, including JPEG, the most common format of them all. For example, compare the two attached images. Both are the same resolution (800 x 533), but one is only 6 kB in file size while the other is over 500 kB. I think you can guess which of the two images is the smaller one.
The "Mbps" number you mention is the bitrate, a very important parameter for the picture quality. It stands for "Megabits per second" and it tells the video encoder how many bits of data it is allowed to use per second of video. The higher the bitrate, the higher the quality will be. However, due to diminishing returns, you don't want to set it to the highest possible setting, that will just waste disk space and network bandwidth. The appropriate bitrate depends on the resolution - the higher the resolution, the higher the bitrate must be to get acceptable quality. For VOD (downloadable video files, as opposed to streaming), it is always better to ask the encoder to aim for constant quality rather than constant bitrate. In other words, you allow the encoder to change the bitrate based on what's going on in the video, thus maintaining constant quality.