You pay $100 bucks (a little more for HD) and that's it.
All it does is go on the internet and run what are essentially apps (like what you run on your phone) but through your TV screen. It's not really as powerful as a computer, or even a phone. That's why they can't get away with charging as much for it (since all it does is play streaming video in a really simple way for integrating with a plasma screen).
Basically you use it to watch shows through streaming video apps. Some apps are free, some apps cost a subscription or require that you have a subscription with whatever company made the app. Netflix for example has an Apple TV app, and if you have a Netflix account, it'll ask you to log in to access movies and shows through it. Hulu has a similar thing for current TV shows. Also, ESPN has an Apple TV app, where if you have log in information with a cable TV account that carried ESPN, you can enter it in and watch ESPN & non-televised ESPN games through the app. HBO has a similar App to ESPN's.
You can do something similar with a PS3 or Xbox, but if you don't want a game console and you think different Apps are a better alternative to cable TV, it's a good product. If you have a bunch of other apple products at home (macbooks, iphones, ipads) it's really easy to sync them with your apple TV, if you want to stream stuff from your gadgets onto your TV.
They don't cost that much to make, and I think apple wanted a lot of people using it at some point, so they price it at something semi-reasonable (hoping maybe they'd go out and get iphones and ipads to go with it, a "loss-leader" kind of thing.)
Roku, which is a competitor of Apple TV, is about 30 bucks cheaper for both regular and HD models though.