Many 3-D games use a first-person or an over-the-shoulder perspective. You, as the game player, either see the world from the character's point of view or seem to be hovering in the air slightly behind the character you are controlling. As your character moves around, you see the world of the game stretch out into the distance. But what you are really seeing is a very clever illusion reminiscent of the backlots of Hollywood!
The world that the game character can actually interact with is a very defined area. If you could pull the camera view up in the air, you would see that the play area is completely self-contained. Other parts of the world that you can see in the distance are actually two-dimensional images mapped onto a flat surface that surrounds the play area like a barrel. The sky is created in the same way, by mapping the sky image onto a large dome or cylinder that fits over everything else.
For more information on video game development, check out these links: