.dmg files are disk images, similar to an
You can think of them like a virtual CD. You put it into the CD drive (mount it), and its contents appear on your computer.
When used for software downloads, they are simply a way to bundle up files, like in a ZIP archive. Their advantage is that it's possible to customize the design (e.g. Finder window background and icon positions, see example below).
The actual program is in a special bundle or package directory with the usually invisible extension
.app. It contains an application's resources, like image files, and the actual binary (the "
.exe equivalent") that is executed when you start the program. If you want to compare it to a Windows equivalent, the closest would probably be the folder in
C:\Program files\ created by a program's installer.
To install such an application from a disk image, you drag and drop it to your hard drive, e.g. the
Applications directory. That's what a lot of disk images try to convey in their disk image design: You grab the application, Adium in this case, and drag it onto the Applications folder: