What is the Frame Skip?

Frame skip, if I recall the specifics correctly, basically allows your computer to skip rendering some frames while playing the game, usually when your PC is underperforming.

For instance, if your PC is struggling to run the game and is getting very stutter-heavy already and the FPS is dropping, if you turn ON Frame Skip, it will just skip some of those frames outright, which in turn makes the game perform better because it has less processing load to handle. A sort of "I can't be at 60 FPS anyway, so why not just drop the extra weight and run better at 30".

If your PC runs Terraria just fine, then there isn't much need to use it.
 
iirc, turning on frame skip can result in some wonky furniture animations (such as for the Autohammer and Solidifier), but other than that there isn't much of a noticeable difference.
 
It also seems to skip frames rendered by your mouse which results on it 'lagging' behind when it is moved.
 
It also seems to skip frames rendered by your mouse which results on it 'lagging' behind when it is moved.

Your mouse does not render frames.

The reason for mouse lag can be a wide variety of issues including: Faulty driver, a couple of windows settings, low frame rate, improper mouse acceleration settings in games, and mouse smoothing settings in games.

Real time Rendering in games is only handled by the GPU. The reason your mouse or aim appears more choppy with low frame rate is the same reason any smooth animation gets more choppy. Your monitor is displaying frames with more time intervals in between each frame as a result of dropped frames from poor performance.

For instance if your character in a game runs across a field for 5 seconds at 60 fps then there are 300 frames or instances where you can see your character gradually running from the start to the end. But if your framerate is only 30 fps then you will only see every other frame from the previous example, so only 150 instances of seeing your character run. This results in choppier footage in low frame rates. Now pretend the character from our examples was actually the mouse moving across the screen.

Does that make sense?
 
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