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Megabus provides relatively cheaper fares to travel between DC to NY. When I started doing the reservation it gave the option to pick seats of my choice. This would cost me additional $1, $7 depending on the seat type. Also it allowed me to skip this step without selecting any seat type.

Then at the final reservation notice it says 'general seating'. What does this really means? Will this allow me to pick any unreserved seats on the day of departure? If so how do I get to know unreserved seats when I'm boarding to the bus?

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Not sure if you meant Megabus is "relatively cheaper" than other bus lines, if so, that's often not true. Over at Busbud we do price research on buses, including Megabus. Bus companies are using ever-more high tech pricing systems that monitor demand and competitors' pricing.

I just did a quick search on Busbud for cheapest DC - NYC bus for Weds, Sept 6th: the cheapest result on Busbud was Ourbus for $12.25 after non-optional fees ($12+fees), beating out BoltBus, Greyhound, Washington Delux and GoBuses. On megabus.com the cheapest is $16.25 after non-optional fees ($13+fees). Just wanted to point out shopping around can be useful. Of course the varied quality of service, stops, and amenities might make something other than the cheapest most attractive.

From first hand experience, I can confirm Spehro Pefhany's answer that the rest of customers can claim seats on a first-come, first-served basis at departure. At bigger stations, passengers line up for boarding and get to claim seats as the board. Things can get awkward if you have a reserved seat but someone else decided to take it anyhow, Megabus drivers have a lot else to deal with, an especially high number of passengers to process and often are hard to get the attention of for helping to clear up the situation.

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According to this site:

Reserved seats are visually distinct with solid blue coloring and are identified by a large number embroidered onto the seat fabric. This number corresponds to the specific seat number customers select on the Megabus.com website at the time of purchase.

Since only a small fraction of the seats are reserved (10 of 80 or so) they should be obvious. You cannot sit in one of the premium seats if you have not reserved it, according to their FAQ.

If you arrive later than 15 minutes before departure you may forfeit your ticket.

Unreserved seats appear to be first-come first-served.

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