What is significance of these variables in given block diagram of system
The part enclosed by the red line is the plant or the system which we are trying to control. Only one set of inputs pass into the system from outside; It is labelled as u. The output of the plant is shown as y. The block diagram inside the red line is only a representation of the actual system. If we break open an actual plant we won't be usually able to see separate pieces which we can label as B, A, C etc.
u is not just a variable. It is usually a physical parameter like voltage, heat, flow etc.
The part enclosed by the green line is the reference signal. We want the output of the system y to follow this reference r. Yes, sometimes it is set by a human being. e.g. a person turns the thermostat dial to 25 deg Celsius. As seen from this example, it need not be zero.
In this diagram, the disturbance input is not shown. Usually it is shown as line going into the system just like u. Unlike u, it is not under the control of the control system or a person.
The part enclosed by the blue line is the control system or the controller. In this particular example, the controller contains inside it, an observer as well as a feedback gain. Depending on the system, the observer blocks may be absent, and only a gain K will be present (connecting y to the left most summing junction). The controller is designed by the engineer. It is usually an electronic circuit or a software program or a combination of both. If we break open a controller (hardware or software), we will usually be able to label the pieces L, K, B, summing junction etc.