They know that everyone knows that there are blue eyed people.

What they don't know is that everyone knows this. In other words, they don't know that everyone knows that everyone knows that there are blue eyed people.

Alice thinks like this:

1. there are blue eyed people (e.g. Bob and Carol)

2. everyone knows there are blue eyed people (Bob can see Carol, Carol can see Bob, everyone else can see them)

3. I know that 2 is true, but Bob and Carol might not know. Bob might think that Carol thinks that there are no blue-eyed people. (Of course, in reality, Bob does not think this because he can see Alice as well)