I am confused about something. Say I create a new document in Illustrator and specify that it is 1" x 1" at 300 dpi. In the newly created document, I turn on rulers and it shows 1" x 1". Very good. However, when I go into preferences and switch the ruler units to pixels, it shows that my document is 72 px x 72 px. It *should* be displaying 300 px x 300 px, shouldn't it?
What you have ticked is raster effect settings, which only applies to raster effects such as Effect>Blur>Gaussian Blur.
When you place a raster image (whether linked or embedded) it will be too large, but you can just change its dimensions to correspond to the desired resolution (for 300 PPI you can multiply the W or H value by 0.24 (that is 72/300) and Ctrl/CmdEnter to keep proportions.
The contents (number of pixels x pixels) will not be changed (no resampling).
And what Kris said.
If the image or file contains information about its size in fixed size units (not pixels), it will be placed with this size according to ruler when set to fixed size units. If you resize it, Illustrator keeps the original number of pixels in a image which will result in different ppi which is also displayed in the Control bar when the image is selected. Have in mind that the ppi information there may become confusing or invalid if you rotate the image because Illustrator calculates this by mapping the original to the new bounding box of the image.
The pixel dimensions according to the rulers and input fields are used for the default image size when saving for the web and also for the pixel preview. When you print to a postscript printer all pixels of the placed images are used.
Copying and pasting from Photoshop places the image with the fixed size units not the pixel units according to the Photoshop ruler.
That settings does the same as changing effects > Doc Raster Effects Settings, which only applies to effects with btimapped results such as drop shadow. As other posters said, nothing else is affected.
The reason Ilustrator converts 1" to 72 pixels, is Illustrator is also used for web work. Though Illustrator is predominatly used for print, print projects do not work in pixels ao the decision was made to go with 72 to make digital people happy.
You ask a good question, as I wonder what will happen years from now, when people do not even remember monitors started out at 72 dpi.