This was actually a feature added in WordPress 2.9 but now it has been renamed. It was originally known as the Post Thumbnail selector but the folks at WordPress have decided that calling it the Featured Image selector was a better idea. Either way, it is a great tool. It allows you to select which image best represents your post. This image will be used throughout the theme as the post’s thumbnail. If your theme has a content slider/featured slideshow, the image will also be used for that.
There is a plugin called Easy Add Thumbnails available on WordPress.org that automates the set up of the featured image. I am not involved in the development of this plugin but many of my users have suggested it.