There are three distinct but linked concepts to understand here: screen density (pixels per inch/centimeter, or commonly known as DPI from dots per inch in printers), physical screen size (in inches or centimeters) and number of pixels (also known as resolution, in pixels).
These terms are not interchangeable, and you need to understand how they interlink to not be confused with the issue. Generally, you can ignore physical screen size since that’s already accounted for in the density. For example a screen 3 inches wide and 300 pixels across will have a DPI of 100. Furthermore phones screens tend to have about the same physical size, even if the number of pixels is very different.
So, let’s consider the screen of a G1 or Hero which has a resolution 480×320 and a density of approx 160dpi. An image 300 pixels wide will be 1.875 inches across. This is calculated by pixel size (300) / density (160). Now if you compare this to the screen of the Nexus One, Droid or similar, these models have a higher resolution screen of approx 800×480 with a high density of approx 240dpi. If you display the same 300px wide image, it will now only physically be displayed at about one and a quarter inches across. In other words, it will be much smaller. This can be a problem because if the image contains text, then the text might not be readable anymore.
Android can be told to automatically scale images to fit these different screens so that it still looks to be the same size. This is done by setting sizes in Density Independent pixels. If something is 100dp wide, it will be 100px wide on a medium density screen. On a high density screen, it will be 150px wide, but they will both look about the same size on the actual screen. However, if you do this, your image can go a bit blurry. It’s the same as when you zoom into a photo too closely in a picture viewing program; the edges go blurry since it ‘stretches’ them while you zoom.
The way to solve this is to use the mdpi, hdpi and so forth folders. You’re giving Android an image that has already been scaled, so that it doesn’t have to do it itself. Obviously if you just stretch the image yourself in Photoshop, then it won’t look any better. But normally one is resizing very large images down to make them fit the mobile screen. In that case, you just resize them three different times, each into a different resolution.
So to finally answer your specific question: if you have an image placed in your mdpi folder, it will be exactly the same size regardless of the screen resolution, as long as they are all the same density. What will change is how much space around them, e.g. a 320x320px wide image would fill most of a 320×480 screen, but only about a third of a 480×800 screen. However, as noted above, generally the higher resolution phones also have a more dense screen. In that case, Android won’t look in your mdpi folder for the image – it will go to the hdpi folder, and if it can’t find it there, it will take the default “drawable” folder. Then if you’ve used DP it will automatically scale it, or if you’ve used PX, it will leave it as is, and it will just look smaller.
There! A very long answer for you. I hope it makes sense.