pictures taken with digital cameras will come with inherent noise or "stray electrical signals" and the image will tend to be a bit unsharp compared to film camera. This is a characteristic of the image sensor rather than any defects per se. We call these "defects" artifacts of digital images.
a noise reduction s/w tries to remove this noise and at the same time increase the sharpness of the image to correct these digital artifacts. The s/w will allow you to dial in the degree of noise reduction or sharpness you want. What you saw in the picture you posted is a case of too much noise reduction resulting in loss of contrast and increased softness of the image, hence the nose "merged" with the face.
You can check out s/w like Noise Ninja for more info.