The Knowles S1950, like the other microphones in the iPhone 4, is comprised of two main parts: the MEMS and the ASIC. You can think of it this way: the MEMS does all the work, and the ASIC does all the thinking. Together, they make an awesome microphone.
Looking at the S1950 MEMS die gives you an idea of how it functions. Like a microscopic vesion of a condenser microphone, the microphone itself has a simple design, comprising of two parallel polysilicon plates (very thin plates made of multiple small silicon crystals) that act as plates in a capacitor.
The upper plate is perforated with an array of small holes, and is separated from the bottom plate by a small air gap. As the sound waves from someone's voice hit this top plate, it deflects very slightly. Because these two plates hold electric charge, these deflections cause minute changes in the electric field between the two plates. The fixed bottom capacitor plate senses and relays these changes as an analog signal.