Iterative development involves breaking down software development into smaller chunks called increments or iterations. With each iteration, additional features are designed, developed, and tested until a fully functional application is ready. Incremental development builds functionality in thin layers, with each increment building on previous work. An example of iterative development is a team building an e-commerce site, starting with basic checkout functionality and payment by debit card, then refining and adding additional payment methods in subsequent iterations until the functionality is satisfactory.