When we speak of a diamond's clarity, we are referring to the presence of identifying characteristics on (blemishes) and within (inclusions) the stone.
If you think about the incredible amount of pressure it takes to create a diamond and the fact that natural diamonds are not grown in a sterile laboratory, it's no surprise that most diamonds have flaws.
Basically there are two types of flaws: inclusions and blemishes. Inclusions refer to internal flaws and blemishes refer to surface flaws. However, in the diamond grades listed below, you'll note that none of the grades include the term "blemish" -- for the purposes of grading diamonds, all flaws are called "inclusions."
Inclusions include flaws such as air bubbles, cracks, and non-diamond minerals found in the diamond. Blemishes include scratches, pits, and chips. Some blemishes occur during the cutting processes (most often at the girdle). Diamonds with no or few inclusions and blemishes are more highly valued than those with less clarity because they are rarer.