It still has to be highly compressed. An uncompressed HD movie is something like 25 gb. I don't have or want iTunes so I can't verify it, but I'd be surprised if the files they send are more than 1/10th of that.
The only other thing I can say on the matter is that I was at Macworld today, and they were demoing Apple TV playing an HD movie on a giant screen (probably 50 feet across) and it looked excellent.
The facts on blue-ray: "Discs encoded in MPEG-2 video typically limit content producers to around two hours of high-definition content on a single-layer (25 GB) BD-ROM. The more advanced video codecs (VC-1 and H.264) typically achieve a video runtime twice that of MPEG-2, with comparable quality."
In all likelihood, iTunes is using H.264, or their newest variant. The same as blue-ray. So, in reality, the choice of codec matters a great deal, blue-ray is not uncompressed video (thus, 25GB holds a 2 hour compressed movie), and yes, 1080p is better than 720p.
And it's also worth noting that digital cable, and as far as I know every other on demand HD video service, is also "highly compressed" 720p.
Then you said that "blue-ray is not uncompressed video (thus, 25GB holds a 2 hour compressed movie)" By your own math they would only take up 12.5ish gb if compressed.
I actually am curious what digital cable uses. It's definitely 720p in my area, and probably compressed, but not highly.
What I said is, Blu-ray movies take up on average 25GB with MPEG2 compression. In other words, your original estimate of the size of things was wrong, as was your implication that blu-ray was uncompressed.