The problem is the wrong usage of a closure variable in a loop.
But the solution can be simplified to
$(document).ready(function () {
var $selection = $("#gallery img");
$selection.hover(function () {
this.src = this.src.replace('.jpg', '_edited.jpg')
}, function () {
this.src = this.src.replace('_edited.jpg', '.jpg')
})
}); //End ready