It is better to look at this from the point of view of statistical mechanics. There you have an ensemble of identical systems. The density matrix tells you what fraction of those systems are in state \left|\uparrow\right\rangle and what fraction are in the state \left|\downarrow\right\rangle. So if you want to know expectation values of operators, you must take into account both the quantum expectation value, and the fact that you have a certain fraction of systems in one state, with one expectation value, and a certain fraction in another state.
Now, if you believe that quantum mechanics is correct, then because of its linearity properties, you as an experimenter can only interact with one universe (your own), with one pure state \left|\Psi\right\rangle. You are free to postulate an ensemble of universes, but your expectation values will only depend on \left|\Psi\right\rangle (again, because of linearity). So why do we care about mixed states? Well, the universe is a closed system, but most of the time we deal with open systems, meaning there is a part of our system that we cannot measure.
So let's start with a density matrix of a pure state. You'll agree that this is equivalent to a pure state, so just a change of notation. Now, if we can only make measurements of one part of the system, then in order to take expectation values using the (pure) density matrix, we need to "trace out" the variables of the system we cannot measure. This is called a "reduced density matrix". The reduced density matrix will generally "look like" a mixed state, i.e., an ensemble.
One example is that if your system is in contact with an infinitely large heat reservoir, then the entire system (system + reservoir) is in a pure state, but if you don't know about the reservoir then your system will be in a mixed state with thermal distribution. The same thing happens in classical statistical mechanics where the entire system is described by a microcanonical ensemble, but your system is best described by a canonical ensemble.
I have a write-up about it here: http://www.physics.thetangentbundle.net/wiki/Quantum_mechanics/density_matrix#Reduced_density_matrix if you are interested.