What does this mean? The jpg is only 160 KB and the site itself is only taking up about 3 MB. How could this exced an 8 MB limit, and where is this limit set?
This is the default memory limit of a single PHP process. Generally, for any "major" application like Drupal, I don't run PHP with anything less than 24M per process. Look for "memory_limit" in your php.ini file (which could be located in /etc/, /etc/httpd/, /etc/apache/, /usr/local/etc/ - depends on your setup). Change it to 24M, then restart the Apache webserver and you should be fine.