I had to deal with an issue where I had to reinstall Windows 7 recently, and had (thankfully) made a 'backup and restore' backup onto an external hard drive before that. Is there a difference between that and creating a system image from the same Control Panel option, OTHER than the fact that you cannot choose what to restore by using a system image? Does the system image take up less space?
Windows Backup allows you to do incremental backups, but won't back up the following items:
A image on the other hand is a complete copy of the drive, so everything is saved. [more info]
A "system image" is not a specifically-defined term but generally backups called system images are a full and exact copy of a partition/drive as it existed at a point in time. Some software which takes these images can compress the data or do a sparse copy (only copy used data blocks), but generally system image backups are the same size as the volume for which the backup is being taken.
In my experience with Windows 7 backup, it is as I described above, a full copy of your main system drive (partition) without compression and non-sparse. Other software or methods which employ one of the two items mentioned previously will quite likely result in smaller backup sizes compared to the default Windows backup tool.