Photoshop 7 is a 7 or 8-year-old product. You can't expect it to work with RAW files for cameras which post-date it, unless you use a third-party plug-in.
Most cameras support various jpeg qualities. Your K200D, for example, has 3 I seem to remember. The Canon S90 has just two. The problem with jpeg in general (apart from no way of preventing lossy compression) is that in most cameras it's an 8-bit color depth, while the RAW file can be up to 14 bits. One example of what this means in practice: the jpeg can show blown highlights (i.e. bright areas unrecoverable by post-processing) that may not exist in the RAW file. Most cameras only offer one or two color spaces: sRGB and Adobe RGB. So you're losing gamut that is available at the sensor, especially with sRGB. A comparison might be, if you only shoot jpeg, it's like getting prints without the negatives: it's a lot harder to fix stuff.
jpeg is effectively a viewing format. You really want the original data to be in a better format.