The above commutation relations define the Lie algebra su(2), and indeed su(2) may be identified with the Lie algebra of all real linear combinations of the Pauli matrices, i.e. with the Hermitian 2x2 matrices with trace 0. In this sense, the Pauli matrices generate su(2). As a result, the Pauli matrices can be seen as infinitesimal generators of the corresponding Lie group SU(2).
The Lie algebra su(2) is isomorphic to the Lie algebra so(3), which corresponds to the Lie group SO(3), the group of rotations in three-dimensional space. In other words, the Pauli matrices are a realization (and, in fact, the lowest-dimensional realization) of infinitesimal rotations in three-dimensional space.
In quantum mechanics, the Pauli matrices represent the generators of rotation acting on non-relativistic particles with spin 1/2. The state of the particles are represented as two-component spinors, which is the fundamental representation of SU(2). An interesting property of spin 1/2 particles is that they must be rotated by an angle of 4π in order to return to their original configuration. This is due to the fact that SU(2) and SO(3) are not globally isomorphic, even though their infinitesimal generators su(2) and so(3) are isomorphic. SU(2) is actually a "double cover" of SO(3), meaning that each element of SO(3) actually corresponds to two elements in SU(2).
Together with the identity matrix I (which is sometimes written as &sigma0), the Pauli matrices form a basis for the real vector space of 2 × 2 complex Hermitian matrices. This basis is equivalent to the quaternions, and when used as the basis for the spin-1/2 rotation operator is the same as the corresponding quaternion rotation representation.
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