When the phone system was automated, instead of operators connecting your line to the line of the person you wished to call, automatic switches were used to make the connection. The switches worked by detecting pulsed signals on the line. Each time a pulse was detected the switch would ratchet to the next position. There were a total of 10 positions on each switch, one for each number 1-0 (0 being 10 pulses). For each digit dialed another switch would record the number of pulses until finally the phone system could route your call. The pulses were actually created by very quickly putting the phone back "on hook" and then back off. This is why when you see old movies and the character is quickly pressing the hook repeatedly saying something like "Hello, Operator?" After they "pulsed" the hook 10 or more times, the first switch would register a 0 and you would hopefully be connected to the operator. More often than not, in these situations the line had been cut and the phone wasn't working anyway! But in theory, if you were quick enough this would actually work and you would get the operator.
As you can imagine, all those mechanical switches took up a lot of space and I suspect they were relatively unreliable and expensive to maintain. With the age of the transistor a more electronic means of switching became possible and "touch tone" was born. Touch tones were based on a system called Dual Tone Multi Frequency (or DTMF). It took quite some time for all phone systems to upgrade to this "new" format. As late as the early 1990's the phone company at my in-laws' house did not support DTMF and you had to set your phone to produce the old fashioned pulses!
The idea behind DTMF is that each button will produce two tones (dual tone) at two different frequencies (multi-frequency). As the buttons are arranged in a matrix on the keypad, it's easy to see the encoding. Basically one of the two tones is determined by which row of keys, and the other tone is determined by which column of keys. The key at the intersection of a given row and column produces the two tones represented by that row and column. The DTMF spec actually includes another column of keys (for a 4 by 4 matrix) but these are rarely seen on phones.
Even though each button produces two tones, you do still perceive each key as a different note. It's not quite the same as playing the note on a piano, but it's still recognizable.
Nowadays we use cordless phones and cell phones that produce DTMF tones, but unlike phones in the past where you always could hear the tone when you pressed the button, on newer phones the tones aren't sent until you hit "talk" and even then they didn't come out of the speaker.
Now for the part of the story concerning what has been lost.
Since you could more or less recognize notes from the touch tones, it was possible to actually "play" a simple song on your phone. As a kid, I remember working out the tones to play Happy Birthday and on my relatives' birthdays I would call them up and launch into my composition and hope that they didn't hang up before they had a chance to recognize the song. In today's world of text messages and posting birthday wishes on Facebook walls, I'm afraid those much simpler days are gone.
