First things first: if you haven't already, go back and read Mercutio's Queen Mab speech in Act I, Scene 4. (Or give yourself a little treat, and watch this version from Franco Zeffirelli's 1968 version.)
Let's start with the basics. According to Mercutio's vivid description, Queen Mab is a tiny fairy that rides around in a coach made out of an "empty hazelnut" with spider's "legs" for wheel spokes (1.4.11). The coach is driven by an even tinier "grey-coated gnat" and drawn by a "team of little atomi" (tiny atoms).
Queen Mab spends her time galloping over the noses and lips of sleepers, filling their dreams with wild fantasies (lovers dream of love, soldiers dream of slitting throats, lawyers dream of winning lawsuits, etc.). Mab (whose name is also a slang word for "whore") is also kind of scary. When she's in a bad mood, she plagues women who dream of "kisses" with nasty sores ("blisters") that might just be cold sores but might also be nastier things, like pox from syphilis, and she's fond of making young, virginal girls have naughty dreams.
So, why is everything about Queen Mab so tiny and sexual? To answer that, we need to think about what it is that prompts Mercutio's wild rant in the first place. Fed up with Romeo's lovesick moping for Rosaline and his claim that he had a steamy "dream" the night before, Mercutio taunts his buddy by saying that Queen Mab must have paid him a visit. Mercutio also informs Romeo that dreams "are the children of an idle brain," which is another way of saying that Romeo is an idiot and his dreams about Rosaline are ridiculous (1.4.12). Given the context of the speech, it seems like Mercutio is suggesting that, like Queen Mab, dreams (especially Romeo's) are small and insignificant.
Pretty wild stuff, don't you think? It's easy to see why, in Baz Luhrmann's 1996 film, Romeo + Juliet, Mercutio takes a hit of ecstasy before delivering his "Queen Mab" speech—the whole thing can seem like drug-induced nonsense. Romeo all but says so when he yells, "Peace, peace, Mercutio, peace! Thou talk'st of nothing" (1.4.12).