OK so W7 differs slightly but you got there in the end and found recording devices - a microphone is just that. I'm in Linux at the moment so I can't check a W7 system but does it not - like XP - offer a test? Also, is it showing the right device as default?
Could be worth checking that the speakers are the right type in Sounds>Volume then click the lower of the two Advanced buttons. If they're set to, say, monitor speakers and they're actually the desktop variety, change as necessary.
I have this problem and its driving me CRAZY, ive signed upto this forum purely because of it as I couldnt find ANYONE with the problem elsewhere...
Ive spent hours tampering with stereo mix and my audio devices and my computer just seems to playback audio and doesn't record my voice at all...It worked fine this morning then just started happening later the same day :S