What happens to application data when I update vs uninstall an iOS app?
It's a delete and re-install. A new copy is downloaded from the AppStore, and the actual application file is deleted off the device, and then re-copied. It's the same operation as when you uninstall, just with an immediate install.

The data for the application is kept separately, and when you choose to delete an application via the springboard, it will prompt you to delete the data associated with the application.

When updating, it is assumed that you want to keep this data, and it is also part of the backup that is made when the device is backed up.