As user Fabjaja notes in the comments, Wessex was originally a kingdom in Anglo-Saxon Britain. While some of its peers survive in modern nomenclature (such as the county of Essex), Wessex had not. The name would have been largely unfamiliar to readers in Hardy's time - it is almost entirely thanks to his writing that it re-entered the modern vocabulary. Although not in common usage, most folk nowadays would understand that it refers to the geographical area where the books were set.
He first used the term in chapter 50 of Far from the Madding Crowd. Prior to this he had already written four novels, none of which used the word, instead referring to the area by its proper name, the county of Dorset.
Far from the Madding Crowd was the most popular of his books to date, however, and he attributed this partly to its setting in a semi-mythical rural England. The name recurs in the very first sentence of the next novel, The Hand of Ethelberta.
It is worth remembering that in Hardy's time, novels often started life as serials, and print runs were small. So, as his popularity increased, he had the opportunity to revise and edit subsequent editions of his books. He appears to have used this opportunity to change the place-names in his early books into fictional ones in his expanding mythology, making it seem more pre-planned than it really was.
The reasons why he did this, then, are partly commercial - his audience liked it. At the time, Dorset was one of the least populated parts of the country. City folk found its rural rituals fascinating. In 1912 he wrote in his General Preface to the Novels and Poems:
"the region designated was known but vaguely;"
It seems they preferred it in fictionalised form than in actual place names they might be vaguely familiar with.
Hardy, however, also felt that mythologising it offered him more creative freedom. Again in the General Preface he wrote:
"I considered that our magnificent heritage from the Greeks in dramatic literature found sufficient room for a large proportion of its action in an extent of their country not much larger than the half-dozen counties here reunited under the old name of Wessex"
Hardy was creating what he saw as his own Greek fiction, a creative space in which he could work in the manner of the classical masters of antiquity.
- Williams, Merryn. Thomas Hardy and Rural England. London: Macmillan, 1972.
- Kay-Robinson, Denys. The Landscape of Thomas Hardy. Exeter, England: Webb and Bower, 1984.