Increase upload size in your php.ini
Drupal's limits on upload file size are determined by your server's PHP settings (as well as Drupal specified settings that can be set at Admin > Site Configuration > File Upload). The default values for PHP will restrict you to a maximum 2 MB upload file size.
Drupal 4.7.x and above calculates and displays the maximum file size that you can set in the settings page for the upload module based on two PHP settings, 'post_max_size' and 'upload_max_filesize'. Since 'post_max_size' is the limit for all the content of your post, potentially including multiple uploaded files, the upload module limits the size of a single attachment to be 50% of post_max_size, or 100% of upload_max_filesize, whichever is smaller. The default PHP values are 2 MB for upload_max_filesize, and 8 MB for post_max_size.
Depending on your host, changing these two PHP variables can be done in a number of places with the most likely being php.ini or .htaccess (depending on your hosting situation).
For example, to increase the limit on uploaded files to 10 MB:
- Add the below to the relevant php.ini file (recommended, if you have access). Note that for some hosts this is a system-wide setting. However, for hosts running PHP as a CGI script with suexec (for example) you may be able to put these directives in a php.ini file in your Drupal root directory.
upload_max_filesize = 10Mpost_max_size = 20M
- Add the below to your .htaccess file in your Drupal root directory.
php_value upload_max_filesize 10Mphp_value post_max_size 20M
The PHP documentation states that the memory_limit setting also affects file uploading. Generally speaking, memory_limit should be larger than post_max_size. If this is an issue, see the page on how to Increase memory available to PHP (3 methods)

If your changing your php.ini and keep getting server errors
If your changing your php.ini, and your having troubles (server keeps throwing errors) using the examples above, remove the ; from your php.ini files so it looks like this:
upload_max_filesize = 10M
post_max_size = 20M