My guess is that it does binning, but I'm not sure.
If everything else were equal, the 1MP might produce a better picture. But everything is rarely equal.
But don't forget that 8MP camera is probably newer, and therefor (probably) has better noise reduction logic. Also, to justify the higher cost they also probably use higher quality parts in the 8MP camera (less noise or faster AF or maybe faster writing to the memory card... who knows?)