I have this line of code.
class ButtonPanel extends JPanel implements ActionListener
{  
    public ButtonPanel()
    {  
        yellowButton = new JButton("Yellow");
and It works, I thought Java needs to know the type of yellowButton before creating an instance of a jButton like this?
JButton yellowButton = new JButton("Yellow");
can somebody explain how this works?
If it really does work, then that means yellowButton is probably a class field that you didn't notice. 
Check the class again. What you probably have is something more like this:
class ButtonPanel extends JPanel implements ActionListener
{  
    private JButton yellowButton;
    public ButtonPanel()
    {  
        yellowButton = new JButton("Yellow");
        /* this.yellowButton == yellowButton */
        /* etc */
    }
}
If a variable foo cannot be found in a method scope, it automatically falls back to this.foo. In contrast, some languages like PHP do not have this flexibility. (For PHP you always have to do $this->foo instead of $foo to access class fields.)
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