Physical changes are reversible and do not produce a new substance.
For example, Melting of ice and freezing of water are physical changes as there is no change in chemical composition, in both forms the chemical formula of water does not change.
Chemical changes result in the production of a new substance and cannot be reversed.
For example, the burning of paper(Carbon) results in the formation of carbon dioxide which is chemically different from paper made of carbon.
Step 2 conclusion:
Knitting of wool into a sweater doesn't change the property of wool chemically.
Thus Knitting of wool into a sweater is a physical change.