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As far as I know, this setting defines the method and the range used by the encoder to search for pixel movement in the video stream. A higher value means a better method and more time to search. This will normally lead to better quality at the expense of taking more time. It does not affect the bitrate. In earlier versions of Premiere PRO, any value higher then 2 or 3 was a waste of time. Of course with recent CPU processing power the difference in time may not be too significant so a value of 4 should be acceptable.
Thanks Pierre - makes sense. I just can't find any documentation on this thing.
Video compression is about compromises. One of the compromises involves smooth motion or crisp images. You choose using the slider, higher quality gives you crisper images at the expense of smooth motion.
I beg to differ with the last post. Higher quality means exactly that: better images and smoother motion. The price you pay is the time taken to find better matches between macroblocks in order to save bits which you can then use to encode your images therefore getting better quality without increasing you bitrate.
As for documentation you can download the manual for the MPEG Encoder from the MainConcept website. The Adobe Media Encoder is based on that encoder. The manual will make your head spin.