Mercutio uses this proverbial expression to mean to waste time. To “burn daylight” means to waste the daylight hours, which is the only time work can be done. But Romeo thinks he means burning candles or torches during daylight, which would be a waste of resources, not a waste of time. In explaining what he meant, Mercutio relates the two: it's nighttime, but by standing around talking instead of getting to the party, they are wasting their torches, just as they would if they burned them during the daytime.