I actually just answered someone else's question that was kind of linked to this. So, if you'll forgive me for it, I'll just copy/paste my reply here, as well as post the link to the original page here.
The reason why the brightness bar is still an option when auto brightness is on is two-fold. First, on the lock screen, when you are putting in your code or just checking time or whatever, the IPhone/IPod Touch uses the actual brightness bar setting for the brightness on lock screen. Auto-brightness only works after you unlock the device (by unlock, i mean the point in time where you can click on apps and such).
Also, the brightness bar sets a quasi-minimum limit, like, if you go into a darkened room like a movie theater, the auto-brightness will dim the light, up to the level that you have your brightness bar. Kind of like the volume limit for music, except this sets a minimum value instead of a maximum. There are situations where this doesn't apply, which is why i called it a quasi-minimum limit.
For example, if the place you are in is like, literally pitch black (or as close to it as you can achieve, then the difference between your set level and the level the auto-detector wants it to be, is considered extreme, and the auto-detector will override the set level, and put it on the lowest possible brightness.
Hope this helps, seeing as I derived all of this from personal experience with my own usage of the IPhone 3GS and IPhone 4.
Oh, just a note, i mentioned that while on lock screen, the device will use your brightness bar settings, yeah, that only works when it's NOT on the charger. placing the device on charge will automatically put the new lock screen (the one that shows a picture of a battery) on the highest brightness setting.