On the 'live' cd it will contain a few compressed filesystems in the form of a single file. These are called loopback file systems. You mount the loopback file systems and the data is read into memory as you access it...
Also it helps that the nature of Linux is to have strong barriers to users having access outside their own home directories and /tmp directories. This has a side effect that allmost all the programs you use can be used on a read only file system with only needed write access to /tmp and /home.. which works out great for a cdrom system.
Not all loopback file systems have to be read-only, but in this case with the cdrom it has to be.
Also there are other tricks they can do. Like setup a file system, then mount another system ontop of that one so that you can read and access the 'bottom' system, but when you make new files it gets added to the new one. I forget what that is called, though.
But mainly... The main / (root) file system is mounted read-only and is a loopback system on the cd.
Other ones include /home/ and /tmp and those would be mounted in tmpfs inside ram as a 'ramdisk', then others like /dev/ and /proc/ and /dev/ are "virtual" file systems that are naturally mounted in ram even if you just using a normal linux install.
Loopback file systems are cool, and it's also the easiest way to setup a encrypted fs in Linux.
For instance take your ISO image file. It's a cdrom image, but it can be mounted as loopback if you wanted.
So if you have a iso image file and you want to try to mount it loopback you go like this:
(say it's called randumb.iso)
mkdir temporary
sudo mount -t iso9660 -o loop,ro randumb.iso temporary/
The mount is the command to mount file systems. the -t iso9660 tells mount that it's a ISO 9660 file system, which is what data cdroms are. This option isn't nessicary most of the time because mount will autodetect the file system, but the autodetect doesn't always work. The -o loop,ro tells it to mount it as a 'loopback' file sysetm and that it's read-only.
So that way when you download iso image you can mount it loopback to get access to it without having to burn a actual cdrom. Also it's good for testing after you use dd to make a iso image or you want to play games that require having the cdrom present (although sometimes game makers will intentially break the ability to make iso images by doing weird things)