The Oyster card is a card that allows you to use the tube and buses as often as you wish within the time you purchase them for. These were easy to get right at the first tube station we went to. Children under age 11 ride for free and children up to 15 cost 1 pound per day.
No - the Oyster card is simply a plastic reusable card. It CAN be loaded with a 7 day travel card and then it can be used as you said (use the Tube/Buses as much as you want in 7 days). It can also, however, be loaded with cash. You swipe it (well, touch it to a touch pad) each time you use it and the appropriate cost is deducted.
Getting an Oyster card is always worth it. They cost 3 pounds but you can get the money back if you return it at the end of your trip. I keep mine and it gets passed on to whoever is traveling to London (it it transferable and reloadable).
Now, deciding what to put on the Oyster card. First, I've never found the London Pass (travel and attractions) to be worthwhile but YYMV. In terms of a travel card or cash:
1) For the travel card, you need to choose which zones it will be good for. The London tube is divided into 6 concentric zones, starting with zone 1 in the centre of London. Most sites are within zones 1/2 so you can get the cheapest card (good only for zones 1 and 2). However, if you travel out of these zones (e.g. go out to the airport, some further afield sites), you'll need to pay for those trips.
2) Only 7 day travel cards can be loaded on the Oyster, but smaller ones (e.g. 3 day ones) do exist.
3) Will you be using the Tube every day or will you be taking day trips out of London? For example, if you are going to go spend the day in Windsor or Oxford, you won't be getting use of your travel card that day.
4) If you do the pay-as-you-go Oyster, the maximum you will charged per day is 50p less than the equivalent 1 day travel card. Any trips after this amount has been deducted will be free. Note also, that instead of paying 4 pounds per trip (the standard "cash" rate), you are charged 1.5 pounds (depends on distance traveled), so take that into account when factoring your costs.
5) I haven't traveled with children, but I know that they also have reduced/free fares in the pay-as-you-go system, so check that out if you are taking kids.
For me, I tend to go with the pay-as-you-go option since I'd be paying for me travel to/from the airport anyway (I usually take the tube) and I know that there are days where I will take few or no trips.
I highly advise the London forum on
www.tripadvisors.com for more info. about your transportation options.