your PATH and CLASSPATH are lists of directories - nothing more. they are separated in the list by a semicolon (on windows).
Usually, when you are working in java, your .java files are in a different directory than where your java.exe (or other executable depending on your OS) lives. so you will be in C:\home\fred\java\source. If you set up your PATH correctly, the OS will search all the directories in your path to see if that .exe is in one, and if so, it will run it.
CLASSPATH works in a similar fashion, except it is used by the JVM to find where your .class files are. so no matter what directory you are sitting in, if you type "java fred", the JVM will search all the directories listed in your CLASSPATH to find the "fred.class" file.
You can put a dot in your classpath to tell the JVM to always look in whatever directory you are currently sitting in when you call java. so if you are here:
c:\home\fred\java\classes, the JVM will look there, so long as you have a dot in your classpath. Note that if you don't have a classpath defined at all, the jvm looks in the current directory by default.
so, if you don't have a CLASSPATH defined (which is usually recommended for beginners), or if you have a dot in your CLASSPATH, you'll probably be fine.
There are only two hard things in computer science: cache invalidation, naming things, and off-by-one errors