Dye

Wool dyes are items used to change the color of wool. They were added in the beta 1.2 update. There are seven "primary" dyes (red, yellow, blue, green, white, black and brown) and nine "secondary" dyes.

Uses
Dyes can be placed with wool on a crafting table (in any position) to dye a single block. It can also be used on sheep to paint them. After shearing, the wool dropped will be of the same colour as well, yielding more coloured wool in comparison to crafting. Additionally, there are naturally occurring gray and black sheep that drop corresponding color wool as well.

Dyed Wool Farming
You can dye Sheep by right clicking on them with the dye in hand. this can be used to your advantage. normally, you will only get one dyed wool block per dye. however, if you dye the sheep first, then punch it off, you will get 1-3 dye, giving you a better drop of dyed wool.