Wool

Wool is a block derived from sheep that can be dyed 16 different colors. Wool blocks are weak, very flammable, and offer little resistance against explosions. White, light gray, gray, black, brown, and pink wool can be found naturally by shearing the respective sheep. Wool is easily hand harvested by hitting a sheep once (a sword will speed up shearing slightly at the cost of 2 uses). Sheep can be injured by fall damage, being set on fire, and contact with cacti, but this damage will not yield any wool in the process.

Jeb mentioned on Twitter that he was working on shears, which may be an upcoming tool for quickly removing wool and/or shearing sheep.

Uses
Wool is a key component of Beds and Paintings and suitable for docks, as wool blocks will stop boats and absorb some impact from collisions in a manner similar to Soul Sand.

Painting sheep (right-clicking while holding dye) is a highly recommended method of obtaining colored wool, as the sheep will drop 1 - 3 blocks of wool when sheared - a significantly larger yield vs. crafting wool with dye. Non-white sheep (brown, pink, black, grey, and light grey) must first be bleached with the application of Bone Meal and re-colored with another dye.

Wild Wolves can be located by looking for randomly dropped blocks of wool on the ground (especially in Forest or Taiga biomes) as wolves will attack sheep while roaming, inadvertently shearing them.

Crafting
*Making wool from string is not recommended as string is much harder to obtain without the aid of an efficient mob trap.

As a Crafting Ingredient
Note: Any color of wool may be used, but it has no effect on the product's final appearance.

Colored Wool
The placement of the wool block and dye doesn't matter as long as they are both in the crafting grid.

Data Values for Colored Wool
Different colors of wool can also be obtained by adjusting the "damage" values in the inventory. * Turns to white wool when placed

History
Wool was added for the creation of carpeting, colorful structures, and in-game pixel art. Before leather was available, wool was also used to craft leather armor.

In Creative Classic mode, wool blocks were known as cloth blocks that came in a set of 16 colours, although the palette was slightly different from the one available in Beta. Three shades of gray were added in Classic 0.0.20a.

Non-white cloth blocks were unobtainable during Classic's Survival Test and Indev unless they were pre-placed into the map file. They were completely removed from the code in Infdev. Placing these blocks on the map would cause the game client to crash, since the blocks no longer existed.

Wool could first be used to craft Paintings in Indev.

In Beta 1.2, cloth blocks were renamed wool blocks and could be 16 different colors. White sheep could be painted by right-clicking on them while holding any dye. Light gray, gray, and black sheep could now appear alongside white ones in the environment.

As of Beta 1.4, brown and pink were added to the naturally occurring palette of colored sheep.

After Beta 1.6.6, the crafting recipe for a block of wool was changed, reducing the amount of string required from 9 to 4 units.

Trivia

 * Sheep have a 5% chance to be black, 5% chance to be gray, 5% chance to be light gray, 3% chance to be brown, and a 0.2% chance to be pink.
 * Without sufficient lighting, hostile mobs can spawn on placed wool blocks.
 * When destroying wool, white wool debris is visible even if the wool is colored.
 * The damage values for the wool and the dyes are the inverse of each other.
 * The only way to get the purple error block is to use an inventory hack. It does not have the same texture as a normal wool block when held, but if placed will turn into normal white wool. It is unknown why this block is in the game but its texture looks like the background of the terrain.png file.