The guy in the demo is using the 'built in' mic' inside the iPhone to record.

Peter, how long ago did you purchase your iPod Touch? The iPod Touch doesn't include a built in mic, but the current generation models include a single 'duo headset-mic jack input' plus a headphone/mic combo headset for plugging into it. Unfortunately, the earlier 1st Generation iPod Touch doesn't support or include a mic input. - Scott