free (1) is a misnomer, it should more correctly be called unused, because that's what it shows. Or maybe it should be called physicalfree (or, more precisely, the "free" column in the output should be named "unused").
You'll note that "buffers" and "cached" tends to go up as "free" goes down. Memory does not disappear, it just gets assigned to a different "bucket".
The difference between free memory and unused memory is that while both are "free", the unused memory is truly so (no physical memory in use) whereas the simply "free" memory is often moved into the buffer cache. That is for example the case for all executable images and libraries, anything that is read-only or read-execute. If the same file is loaded again later, the "free" page is mapped into the process again and no data must be loaded.
Note that "unused" is actually a bad thing, although it is not immediately obvious (it sounds good, doesn't it?). Free (but physically used) memory serves a purpose, whereas free (unused) memory means you could as well have saved on money for RAM. Therefore, having unused memory (e.g. by purging pages) is exactly what you don't want.
Stunningly, under Windows there exists a lot of "memory optimizer" tools which cost real money and which do just that...
About reclaiming memory, the way this works is easy: The OS simply removes the references to all pages in the working set. If a page is shared with another process, nothing spectacular happens. If it belongs to a non-anonymous mapping and is not writeable (or writeable and not written), it goes into the buffer cache. Otherwise, it goes zap poof.
This removes any memory allocated with malloc as well as the memory used by executables and file mappings, and (since all memory is based on pages) everything else.
