Subfolders

Not in iWeb.

You have to put the folders there yourself.

Then how does iWeb recognize them?

iWeb can't recognize them, except insofar as you create hyperlinks on iWeb pages that take you to them.

As for where to put them, are you using .Mac or some other host?

iWeb only recognizes its own folder.

Any other folder is yours to organise.

Usually you use your own folders for files to download, external (to iWeb) HTML pages you use in iWeb's HTML Widget, or any HTML page of your own.

iWeb '08 stores the files in folders with the Site's name in:

iDisk/Web/Sites/foldername.

Store you own folders and files in iDisk/Web/Sites/

You can also use the Homepage (=Sites), Movies, Pictures and Public folders on your iDisk.

To create links to files in the homepage folder, you use:

http://homepage.mac.com/username/folder/file

To files in Movies, Puctures of Public folder, use:

http://homepage.mac.com/username/.Movies/folder/file
http://homepage.mac.com/username/.Pictures/folder/file
http://homepage.mac.com/username/.Public/folder/file

What type of files are you talking about and do you want to present them on a web page or make them available for download?
You can build sub sites in iWeb and publish them within the same folder as your main site on .Mac just the same as you would on a server although this just makes life more complicated and is not necessary.
To make sub sites it is easier if you build them on separate domain files so that they load into iWeb and publish individually.
If you use the standard iWeb navigation menu you will have to provide links to these sub sites as a list so, to "incorporate" your sub sites into the main one, it is better to to build your own so that the links can be incorporated in the main site navigation.
These links would be in the menu like "SubsiteA" and, in the link inspector, they would be linked an external page which is the URL of the sub site eg

http://web.mac.com/username/SubsiteA/HomePage.html

Also make your own navigation in the sub sites and include a link back to the main site.

If you want to do this on a server other than .Mac, you publish the sub site to a folder and rename the index.html file to SubsiteA.html and upload it and the sub site folder to the main website folder.

Most commercial servers will also allow you quite a large number of sub domains beneath a main domain.

On my personal site
http://roddymckay.com
I have a "satellite" site which can be reached from
http://roddymckay.com/Satellite.html

In this case, the satellite is NOT connected to the main site so that it appears as a separate website.

So...do i understand--
if i wanted to make a folder within a folder in my site (lets call them...outer and inner folder respectively), i would create the inner folder as its own Site in iweb--and Publish it separately to .mac, and then hyperlink to it from the outer folder, which is actually a page within my primary website?

in iweb it would look like two websites, but in a browser it would look like one big one.

have i got that right?

With .Mac there is no great advantage to putting a sub site within the main folder. You can publish it as a separate site to .Mac as long as it has a different name from the main site. Then you can link them using "Link to an external page".
The main reason for building a sub site would be so that you can update and upload it without having to do the whole site. For this reason you would build it on a separate domain file. Its a useful way of cutting down the work associated with a large site.
With a large site you divide it into main sections each of which is listed in the main navigation menu.
Clicking on a page takes you to a sub section which has its own sub navigation menu. If your site is huge, the sub sections can be built on separate domain files and published as separate sites but are all linked by the main navigation menu. You obviously can't use the iWeb standard navigation for this. Its better to build your own so that you have more control over what it looks like and also to overcome the problems associated with Google crawling your site.
You can also use this method of navigation once your site gets to be more than about 10 pages as the main navigation gets huge, looks ridiculous and is confusing to the viewer.
Here's an example of a site built with this type of navigation.....
http://www.mirroroftheuniverse.com/
Most people seem to pack a lot of stuff into each web page so that it takes longer to download and you have to do a lot of scrolling. It doesn't cost anymore to publish a 50 page site than a 10 page site. Spread your stuff out over more pages and plan your navigation strategy before you get too far into building your site.