To focus or not to focus?

Hello,

I recently saw a photo where the portrait image in the foreground was really sharp and crisp whilst the background environment all blurred and out of focus.

The camera used was a Canon EOS 500D and the settings 1/60, ƒ/2.5, ISO 250, 50 mm.

Could anyone please describe what is happening technically to create such an image and moreover recommend a budget compact or the like capable of creating such an image?

Thanks in advance,

Jonathan