I haven't played with the Lion developer preview myself, but here's guessing:
One of the "features" of Lion is a restore partition—I think that means a partition that is simply a copy of the install disc. That, combined with the fact that OSX has been able to in-place resize mounted volumes for a while now (originally coded for Boot Camp), makes me think that when Lion installer "app" starts, it simply makes 8GB of room at the beginning of your hard drive, writes its disc image there, then reboots into it.
