Gmail has been undergoing many changes but inclusion of this feature was very essential because inspite of having a Rich Text editor we couldn’t embed image in message body of gmail. Ofcourse, attaching was possible but now you can specify exactly which part of message should have which image to make it more emphasizing.

Add Image Overlay Window
To use this feature, you will need to enable Labs feature called “Inserting images” from Labs tab under Settings of your Gmail account. Also, Make sure you have Rich Text editor enabled (by default, it is enabled for all users)
Via : Gmail Blog

Rohit Langde is a part time blogger who is pursuing degree course in Mechanical Engg.
Well, maybe they were going to do this, but my current version of gmail doesn’t have this, but it doesn’t need it. There is a super easy way to embed graphics in gmail.
First, the graphic needs to be on a web server some place on the internet. Upload your own i you wish. Then go to the web page where you can see it.
Copy and paste it into your gmail in compose mode. (Select the image, use Control C to copy and when back in your Gmail, use Control V to paste it in.)
This just takes seconds, and Gmail copies not just the image, but also the http (absolute address) showing the location on the web of this graphic This makes it possible to be embedded in your outgoing email.
This is an old article and now Gmail has wysiwyg editor which supports pasting data with formatting and hence Image adding outgoing mail has become more easy. Cheers!