The -1/-1 counter is put on Dusk Urchins during the declare attackers or declare blockers step, whichever is appropriate, so it will be smaller by the time combat damage is dealt. (Note that this is different from how the _Shadowmoor_ card Wicker Warcrawler works.)

If Dusk Urchins has just 1 toughness when it blocks, it will get a -1/-1 counter and be put into the graveyard. The creature that it blocked remains blocked, however.