All in all its your true resolution that counts. It's like changing the resolution on your computer. It just makes stuff to a different scale and in doing so, helps make graphics appear much more detailed. Also decreases the amount of Jaggies you see.
Same thing as I have said in everyone of this threads. Your tv is either 720p or 1080i (since it isn't 1080p) and will accept both formats and display one. Whatever you pick the ps3 to output is NOT what will be shown. Your tv will display the format it is natively (CAN'T display another format just accepts it and converts it...).
Yes the ps3 MAY be better at converting than your tv, but should be a minor difference if any
Depends on the TV. smaller than 40" 720p will be the way to go. If you own an LCD TV, interlaced is not the best option. 1080i was very blurry when I was playing oblivion, vs the crisp 720p. Its all about how progressive scan is better suited to LCDs than interlaced.
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