It means calm down , make it simpler . For example ,the university students were having a party and the neighbor asked them to dial it down a notch .(Be less noisy).

On radios, phonographs, and TV sets, volume used to be adjusted by turning a knob. Often the knob would have a dot or pointer and a set of markings--sometimes numbered markings--and thus was a "dial." See http://tinyurl.com/np6cz2o for pictures of volume dials. Thus, to "dial it down" means to turn down the volume on something--to make it quieter. "Dial it down" suggests that you're trying to be reasonable--you don't insist on total quiet, you just want a little less noise.