Currently, Palestinians live in a strip of land on the west coast of Israel called the Gaza strip. There is a fence on the border that separates the Palestinians (Muslims) from the Israelis (Jews). Israel is in complete control of the border and the fuel and other basic necessities of Gaza. Now the Palestinians are resentful of the power Israel has over them and in 2006 voted Hamas into government of Gaza. Hamas is not the government that Israel wants ruling the Palestinians because they believe it is a terrorist organization. When Palestinians get really angry about their situation, groups of them will lob rockets over the border into Israel. I am not sure if Hamas is behind these acts or it is rogue militants. Israel, having close to the best military in the world in terms of weaponry, always retaliates with brute force. Things may calm down for a while, but the hatred and anger is still there and something else will happen to trigger aggressive conflict. On the east side of Israel is the West Bank where another group of Palestinians live. The government there is one in which Israel approves (somewhat) and there is less conflict, but because of religious differences and the concommitant arguments about who is the rightful owners of certain partitions of land (in Jerusalem), it is also problematic.
Good question, btw, and I am glad that you are asking it as so many people don't realize how this small little area can have such an impact on the stability of the entire world.