Hello Baladya and welcome to Seven Forums.
1) You are correct. This option only backs up files. Won't help if your entire operating system fails due to malware, system file corruption, etc.
2) A system image is like a snapshot of the entire hard drive. It will include the operating system, all of your files, folders, installed programs, personal computer settings, Windows updates, the Dell DataSafe and the hidden recovery partition, etc. If your computer gets a nasty virus, or you install a new program and it crashes your computer, you can use the system image and restore your mahine to the exact condition it was in when the image was made. The more frequent you make an image, the more current the restore.
3) A repair disc will let you boot your computer even if the Windows 7 is so badly damaged you can't boot the usual way. It also includes some very important repair functions like being able to use a system image. The repair disc is so important, when you make a system image it will ask you if you want to make a repair disc in case you haven't already made one. Dell DataSafe Local Backup
2.0 is able to restore a Dell computer to the original factory-installed configuration. Supposedly it will not erase your personal files and data. But any other programs that you installed (like your anti-virus, maybe a CD/DVD buring program like Roxio, etc), your personalized computer settings, all Windows updates, etc will be erassed and you'd have to spend hours reinstalling all of those things.
In my opinion, a system image is the best way to go. Save the image to an external hard drive, schedule an image maybe once or twice a month, and you can restore your machine in about 30 minutes (depending how much data was imaged.) It's possible to store the system image on CDs or DVDs but I wouldn't do it. Let's say you have just 20GB of data. It would take about 25 CDs or 5 DVDs to create the image. Each time you remove one disk and insert the next one, you've increased the chance of something going wrong - like not getting a good burn. If only one disk doesn't burn properly, the entire system image will be lost.
Windows 7 has it's own built in imaging tool as you've already discovered. There are other free imaging tools also available that other people recommend. As you become more familiar with the imaging process it would be perfectly OK to try out other software. But for now, I think the built in imaging tool will be more than adequate. I've been using it for 3 years and it's never failed me. Hope this helps.