The rule of variable scope is defined simply: a variable created inside a block (code enclosed within braces: { and }) exists only inside that block. This means that a variable created inside setup() can be used only within the setup() block, and likewise, a variable declared inside draw() can be used only inside the draw() block. The exception to this rule is a variable declared outside of setup() and draw(). These variables can be used in both setup() and draw() (or inside any other function that you create). Think of the area outside of setup() and draw() as an implied code block. We call these variables global variables, because they can be used anywhere within the program. We call a variable that is used only within a single block a local variable. Following are a couple of code examples that further explain the concept. First:

int i = 12;   // Declare global variable i and assign 12

void setup() {
  size(480, 320);
  int i = 24; // Declare local variable i and assign 24
  println(i); // Prints 24 to the console
}

void draw() {
  println(i); // Prints 12 to the console
}

And second:

void setup() {
  size(480, 320);
  int i = 24; // Declare local variable i and assign 24
}

void draw() {
  println(i); // ERROR! The variable i is local to setup()
}