Your scratch disk is where Photoshop gets its memory and space resources to process whatever you're doing in Photoshop. I think by default it uses your hard drive, and it's usually a set number, so if there's not a whole lot of room on your drive, or if the set number is too small for the work you're doing, there's not a whole lot of space in which Photoshop can work. Some people manually set their scratch disk to be a much larger number or to be on another drive entirely. They may even partition their hard drive space and designate one of the volumes just for Photoshop's scratch disk.

It's been ages since I've had to fiddle with my scratch disk settings, so I don't know what the optimal setting would be, but if you increase the numbers or make more room on your hard drive, you should be okay.