How does the ISO work on a Digital Camera

Basicly the charge in each pixel on the CCD chip is sent to another chip that converts it to a number. The charge can be amplified before conversion to get larger numbers. The more the charge is amplified the higher the ISO rating, the problem is that noise is also amplified. Just like if you turn up the volume on a weak AM radio station the static is also louder.

I'm not sure how the cameras decide on what ISO to use in auto mode, each one is probably programed a little different.

The ISO in the camera on Auto mode is selected based upon light levels and on the focal length of the lens. This is adjusted slightly depending upon wich mode you are in. For instance, if you zoom in close to something and lighting is not too good, it'll bump the iso up to 400 or 800 depending upon the camera. Judging from ISO levels in my camera on auto mode, it appears that olympus has developed an program that sets ISO just high enough to offset camera shake based on focal length.

the iso works on the available light the less light the higher the iso will be