The Seven Dwarfs are miners in the land of Tamir whom Rosella helped by cleaning their house. Their leader offered her dinner, and they had a conversation with her. In return they gave her a bag of diamonds, which they insisted she keep. When she tried to give the diamonds back to them in their mine, they gave her a lantern to add to her loot. Rosella used the lantern to light her way through the troll's cave behind the waterfall, and she gave the diamonds to the fisherman and his wife.
Rosella actually didn't plan to clean the house to help the dwarfs initially, but actually take revenge on how rude they had treated her in the mine. Her reasoning was that her own room was messy, and she knew where everyone was in it, if she cleaned up the Dwarfs room they wouldn't be able to figure out where everyone went. However, the dwarfs turned out to be grateful and she couldn't stay angry with them.
Behind the scenes
The seven dwarfs originate from the story "Little Snow White" (aka Snow White and the Seven Dwarfs). The dwarfs were never named in the story. Names have been given to them in the Walt Disney animated version, however (see above).
In the text of KQ4 they are known as the 'Seven Dwarfs'. In King's Quest there are two accepted plurals for the word "dwarf": "dwarves" and "dwarfs". However the seven 'dwarfs' are never called dwarves, and dwarves is mainly used with regards to the evil dwarf of King's Quest 1 and King's Quest II, or the "fire dwarves of King's Quest 8.