a. Is it the case that the engine is revving to 2800rpm but only developing 60% power.
b. Is it that 60% power gives 2800rpm because the air is thinner etc.
Both a. & b. are correct.
Air is thinner (less dense) so a. power is reduced due to less dense fuel/air mixture available for combustion and resultant less power being delivered to the prop. And b. the less dense air offers less drag componant so therefore it can still maintain the higher RPM for the power being delivered. However the thrust being delivered from the prop is also reduced due to the less dense air, to achieve the same percentage power output at altitude a fixed pitch prop must be operated at a higher RPM.
Use power settings the manufacturer recommends for the engine. All settings below redline are not guaranteed to be engine friendly as some may produce unacceptable vibration even at low power settings.