I have been struggling with making an Arduino for a while (was successful in making a breadboard version using an ISP programmer cable). They say that the Arduino bootloader is made so that no external circuitry is required to program the ATmega8. But when I looked into the schematics there is the normal circuit required for the serial connection. Then what does the bootloader actually do?
The bootloader is a small program in the AVR's flash which is never overwritten and runs on powerup. The job of the bootloader is to read program data from the UART and write it to the internal flash. Without a bootloader, the only way to load code is using ISP.
The AVR ATMega8 comes with no code in the flash. Code can be uploaded via the ISP (in-system-programming) pins, using an AVR ISP programmer (or even another Arduino).
For Arduino, the ISP is used only once (at manufacture) - to upload a small bootloader. On powerup, the bootloader runs and communicates with the serial UART (TX + RX pins). Now, Arduino can be programmed via the serial pins using the STK500 protocol.
As the serial pins are (typically) connected to an FTDI USB to serial chip, the Arduino can also be programmed over USB.
You can buy ATmega328 chips with the boot-loader on them here.
They probably mean that if you buy a pre-built, assembled Arduino Uno, you don't also need to buy a programmer. Like with a lot of other electronics starterkits. You can program the Arduino Uno board with just a usb (A > B) cable.
However if you are going to build an Arduino of your own, you of course will need an external circuit (for example an AVR ISP programmer) or the Max232 or FTDI kind of stuff.
The idea behind the Arduino bootloader is that you don't need any specialty hardware or circuits to re-program them, compared to the initial programming of it, or older microcontroller, which often need a dedicated programmer (like PicKit2 for PIC MCUs). The bootloader allows programming over a basic serial connection.
Of course, at the time, you needed the serial link, typically a rs232 converter from TTL to RS232. Then serial ports being phased out, usb to serial became ubiquitous, allowing for that to replace a max232 or similar. And now, the use of USB enabled Atmel microcontroller allow even that to be unnecessary, so a single ic with minimal passive parts could provide the Arduino functions and USB to Serial. Now you only need a usb cable and a few passive to upload a sketch. The initial programming of the bootloader still requires traditional ICSP programming.