The Technical Problem:
Creating an unforgettable video game character in the '80s was all about having a knack for shortcuts. Almost every aspect of Mario's design came from an effort to make him easier to animate. Remember, his first appearance was in 1981's Donkey Kong, an arcade game with processing power that was less than, say, a modern toaster (its 3 MHz processor gave it 1/70,000 as much power as a PlayStation 3 -- those old black-and-white Game Boy handhelds had more horsepower than a Donkey Kong arcade machine).
So Mario's creator, Shigeru Miyamoto, needed to make a tiny block of pixels resemble a human being. He started with the red-and-blue color scheme, reasoning that it would stand out against Donkey Kong's black background. The use of overalls as opposed to a shirt or a muumuu gave definition to Mario's arms, because it meant his sleeves would be a different color from his torso:
Without sleeves, this would have looked ridiculous.
Next came the hat, which was added not because Miyamoto had a stroke of genius, but because he didn't like designing hairstyles. That's right -- the most famous character in gaming wears a headpiece for the same reason you throw a hat on when you're too lazy to run a comb through your hair. As an added bonus, the hat saved programmers the trouble of having to animate Mario's hair when he jumped. Gamers in the '80s didn't expect much, but they demanded realistic hair physics, dammit!
But the big goofy nose and the famous mustache have got to be intentional, right? Nope. Mario's diminutive size made giving him a mouth and realistic facial expressions impractical, and so, much like putting a chair over the vomit stain on your carpet after a wild party, Miyamoto added the honker and 'stache to hide Mario's mouth while still ensuring that his face was more than a monochromatic blob.
via Design Juices
No offense intended to our less-chromatic readers.