Problems with htaccess

[eluser]Unknown[/eluser]
My understanding is the if I use the htaccess code to bypass the index.php in the URI, then when I go to localhost/mydomain/index.php/blog, it should come up localhost/mydomain/blog as the URL, is that not correct? I set the $config['index_page'] == ''; already.

Also, where should the .htaccess file be placed in the directory. If my base directory is localhost/vhosts/mydomainname/ where should the htaccess file go and where should I put the application and system directories?

Thanks