From Mac Guides
A disk image is a computer file containing the complete contents and structure of a data storage device. The term has been generalized to cover any such file, whether taken from an actual physical storage device or not. There are many different file formats for disk images - many of the less common ones are unreadable on the Mac OS.
Disk Images and the Mac OS
A disk image format that is recognized by Disk Utility, when double-clicked, mounts a virtual volume (like a CD, hard drive, or flash drive). A disk image in the .dmg format can be practically any size and can compress its contents. Many Mac OS X software titles and updates distributed over the Internet come as disk images because this format properly retains file permissions and prevents file corruption. For more information, see Installing Applications in Mac OS X.
Disk images can be created through Disk Utility or with the command-line utility "hdiutil". Images can be made of entire volumes, or simply from a collection of files and folders.
OS X disk images typically carry the .dmg file extension. Older disk images from pre-OS X days may be .smi (Self-Mounting Image) or .img.
Use disk images to securely store your data by creating a disk image with read/write access, then adding 128-bit encryption; the passphrase can be saved in your keychain, but best practices dictate that you don't to avoid possible data theft. Use this method to store data on removable media such as a USB keychain or secure, archived backups on CD-R/DVD-R.
|File Format||Mac Programs that Support it|
|File Extension||Created by||Usage||Disk Utility||Toast||Dragon Burn|
|.dmg||Various Mac OSX||General Purpose - Mac OS X only||Yes||Yes||Yes|
|.toast||Toast||General Purpose - Mac OS X only||Yes||Yes||Yes|
|.nrg||Nero (PC)||General Purpose||No||Limited||Limited|
|.bin/.cue||Various||Exact copy of CD (PSX, VCD)||No||Limited||Limited|
|Note: Although some programs claim to support different disk image formats, in reality their support can be limited|
See also Wikipedia:Disk image.