The first app to pull this admittedly excellent trick was called iDisplay, but it was slow and buggy. Thankfully, Air Display takes the pain and frustration—and most importantly, the lag—out of using the iPad as a spare monitor.
As far as I can tell, Air Display (from the same people who make the fantastic Air Sharing app) uses the same fundamental trick as iDisplay, setting up a virtual second monitor, and sending it to the iPad over Wi-Fi, presumably using VNC. As such, the end result is quite similar: With Air Display, your iPad is a second monitor for your Mac—you can adjust or arrange it in your display preferences just as you'd adjust or arrange a regular monitor. Setting up the app is as simple as downloading a client for your Mac, and selecting your iPad (running Air Display) from a pull-down menu in the Menu Bar.
Luckily, this is where the similarities end. Air Display is much, much faster than iDisplay, to the point that there's no lag at all in the mouse cursor, typed text shows up instantaneously (in most apps—some, for whatever reason, slow down during text input), and windows move with enough smoothness to be, at the very least, controllable. There's still noticeable lag during scrolling, which gets worse depending on the size of the window, and you won't be able to watch video on here. In fact, even browsing the internet is a bit annoying.
The client app is more refined than iDisplay's, by which I mean it works, and doesn't leave weird, residual extra displays when you're not using the app. Lovely. (A neat little trick I picked up: If you don't like OS X reconfiguring your monitors every time you leave the Air Display app to answer a notification, you can set it to run temporarily in the background using the Jailbreak app Backgrounder. It works more or less flawlessly.)
When I imagine using the iPad as a second monitor, I imagine specific use scenarios: In portrait mode, it's where I'll keep my AIM windows, my Photoshop pallete, and my Twitter client. In landscape mode, It's where I'll keep RSS feed refreshing all day, or display Giz, to see how a post has turned out. It's a supplementary monitor, which in my mind makes some slowness acceptable—but not too much. Air Display rarely slows down too much.
My only hangups? In order to keep things smooth, Air Display employs some fairly aggressive compression, which is only apparent when things are moving onscreen. (Immediately after you stop scrolling, or moving a window, the compression artifacts disappear.) And it's not great at accepting input via the iPad's screen, limiting you to left-clicking, left-click dragging, and erratically registered double clicks, with no provision for right clicks. That said, if your goal is simply to use your iPad as a second monitor, you'll probably be fine just using your mouse. Touch input is icing on the cake.
But then there's the price, set at $10 for launch. But it's an easy value judgment: Do you need a second monitor for your MacBook, for all the little desktop detritus you accumulate during the day? Need a place to shove all your social apps, or a second workspace for keeping notes? If you have a use like this in mind, $10 is a fine deal. If you don't, it's probably a bit high.
Faster than its competitors
Easy set up, few bugs
Still too slow for some applications
Expensive, and Mac-only