Gray: Inferior. Grey items are useless, sell them to merchant White: Normal or Superior (not sure whats the difference). Just regular items. Usually you should sell them to vendor Purple: Magic items. have magical properties. Some of these are very good items. Good for equipping or salvaging, or selling in AH if very good. Yellow: Rare Items. Dont sell them to merchant. They are usually the best. Either equip them, or put in Auction House for sell Legendary: These are ultra rare. You should use it, or it not certainly sell it, you will get a lot of gold for this
there are also green items, which are story/lore items and cannot be equipped (although I've also heard that set items are green, but haven't run into one yet so can't confirm)