file is intended to be a bit of a poorman's DNS
system. For small networks
a complete DNS is often not needed, but as the number of nodes
grow it is often hard
to maintain hosts
files across a number
of machines, that is when a complete DNS
system is requied. Systems using the internet
almost always use DNS
because, let's face it
, who wants to have a file with millions of hosts
Also the hosts file is useful to add in quick aliases for machines instead of calling up the network administrator to ask to have a name assigned to a machine.
I know this information applies to GNU's inetd and possibly others.