I get the same behaviour - when I hit Submit, nothing happens (no file is uploaded and no thumbnail is displayed) - using IE7 and FF3.0.10. Note when I hit Submit and no file has been selected, I do not get the message 'Please select a file'.
I do not know very much about JavaScript and even less about AJAX, but it seems to me that the behaviour and error are pointing to a JavaScript issue.
I downloaded the latest jquery.js (v.1.3.2) and the latest jquery form plugin - jquery.form.js (v2.28) and got the behaviour above.
So I went to the http://www.finalwebsites.com/ and grabbed the jquery.js and jquery.form.js versions being used on the site and copied them to my site.
And now I get the behaviour I expect - I can upload an image and display on the page - just like the php/ajax upload example.
Thanks for for helping and thanks for creating the php/ajax upload system - brilliant!!! Just what I was looking for.