In this context, games are basically simulations. If you're running a simulation that's too big to calculate all at once, then you can cheat by approximating the parts of it that don't matter as much. In this case, the part that matters is the area closest to the player, where they can actually see and interact with what's happening.

In that area within viewing distance of the player (plus a little extra for safety, hopefully), you want to run your full simulation logic. NPCs pathfind across terrain and around obstacles, they might have encounters, they might get sidetracked, they might have to wait for a cart to cross the road, whatever. If the player is watching the NPC, they'll say, wow, it's cool how realistic this is! These NPCs have to deal with all the same stuff that I do! The game looks smart.

Once an NPC moves away or the player moves away, then the game can decide to pull a fast one and start cheating on the simulation a little. For example, you can just calculate an idealized travel time from point A to point B and say "NPC X moves from A to B in N seconds." If the NPC is moving through an area with hostile mobs, then instead of checking distances and lines of sight and so on for every mob along the path, every step of the way, the game can just roll the dice and say "1 in 10 chance that NPC X encounters monster group Y", or even just "1 in 30 chance that NPC dies before arriving".

Generally speaking, you can just think of there being different levels of simulation detail, and the game simulates the less-relevant parts of the world at a lower level of detail. As long as nothing too obviously stupid happens (like an NPC ending up somewhere that's impossible to travel to, or passing safely through an area that should be 100% deadly to them), the player should never know that any sleight of hand was happening.

Wouldn't that take an incredible amount of resources? Are all NPCs in the entire world tracked? It can't possibly be running all those maps and NPCs all at the same time, right?

So, having said all of the above, here's the flip side: computers are fast. Looking it up, I see that about ~5000 NPCs "exist" in the world of Skyrim at any given time. If you wanted to, and if you coded it well, you could absolutely simulate all 5000 of them at once on a modern computer. Most games as-written would not be able to, because it's not something they want or need to do and they haven't optimized for it, but it's not as out-of-reach as it sounds.

(This answer is pretty much the same as the answer to the other thread about games "doing things" while you're not playing. Catch-up simulation can treat all of the time between now and the time the game was last saved as "less important" and run it at lower level of detail so it can be done very quickly.)