In Sims 2, time stopped for everyone outside the family you were playing. If you always played the same household (as I did), this created a weird scenario where generations of your Sims would be born, grow up, grow old, and die - all while the neighbors and family friends remained unchanged.
One side effect of this was memorizing and learning to love your NPCs. It was always nice to see a new generation of Sims get purse-whipped by Mrs. Crumplebottom! Another side effect is that you could literally kill off every other Sim in town, leaving your own Sims to repopulate the entire neighborhood. (Several challenges revolved around this scenario, including Last Sim Standing and various Apocalypse challenges.)
Time flows for everyone in Sims 3, assuming you have Story Progression on. (By the way you can turn it off in your Options menu, if you want to.) Every Sim in town will go through a series of life changes and eventually die. New Sims will move in; other families will move out.
The game seeks to keep a balance of NPC Sims, so that your town never gets too empty or too crowded. If you have your Sim read the daily newspaper, you will learn about the basic actions that have taken place in the name of Story Progression. The newspaper tells you which families have moved into town, and which have moved out. It also covers births, marriages, and deaths.
I don't often think of Story Progression, but I ran into it the other night. I went looking for the Baker family, to see what had happened to them in my game. I have played Twinbrook for 16 weeks of in-game time. (You can see how much time you've played that family by hovering your mouse over the clock readout.) I wondered if they had moved past the stereotypes they represented, or what.
Alas, I found that their house at 23 Puddlewick Drive was empty. Searching in Edit Town mode, I learned that there were no Bakers in my town of Twinbrook. So long, guys! I guess they all moved out, or possibly died. It's hard to say - I really wish you could research this kind of thing in-game, maybe at the library or at City Hall.
Story Progression can do some funny things, too. I know a player who downloaded a family of Sims based off characters from the new Battlestar Galactica. She added to the game as non-playable neighbors of her main family, so that she could keep an eye on them. A few weeks later she reported that Starbuck was pregnant with Bill Adama's baby, and Tigh had married Laura Roslin!