Simply, a system image is a snapshot of the Win7 system files at the moment when it was made.
It would save you having to reinstall windows with all it's updates to bring you back to where you were (very time consuming), again, if you bricked your hard drive or did something really catastrophic to the windows installation - if you use the win7 backup option it will ask if you want to backup your system image in addition to your files.
You really only need restore points for the c drive - the menus allow this and you can limit the number of restore points by limiting the space available - I think I mentioned this on the bios thread - mine is about 3.7gb? and I had 4 or more.
Yes, I imagine you can formatt different partitions differently but I've never tried directly.
If one installs a linux system on the same drive as windows, unless you instruct it differently, it will do that, so I have done it but never thought about it in that way.
Shadow copy I have not heard of but I will read up about it now you mention it.
Must make dinner for mrs F so not till tomorrow!!!