Buying a used Mac from any source is best left for experienced Mac users, for the very reasons you described.
At best you purchased an expensive education, at worst, stolen goods.
All said and done its now asking me to input my Apple ID and then it says my ID has not purchased the operating system.
A 2008 Mac would not have had OS X 10.7.4 "Lion" already installed, and it is impossible for you to install it from the Recovery partition since the license to use Lion is not transferable by any means. The seller (more than likely, the thief who stole it) erred in not restoring the Mac to its original condition before selling it to the pawn shop. Without that MacBook's original System Install DVD - which the pawn shop didn't supply, right? - it will not be useful to you.
There are no "hard copies" of Lion available. Lion exists only as a download from Apple, whose servers check your MacBook for a legitimate purchase of it.
Your best alternative is to phone Apple at the number shown on the Apple Online Store website. Explain that you purchased a used Mac and require a replacement System Install DVD. Use those exact words. Have the MacBook's serial number ready for them - it will be required.
Determine the Mac's serial number using the following: http://support.apple.com/kb/HT1366
Apple will collect a nominal fee, $25 or so. Once you get the disc, boot from it by starting the Mac by holding the c key with the disc inserted, and pray the original owner did not configure a Firmware Password.
Reinstall its original operating system from that disc, after which you will have reached Step 1 toward using your Mac.
After installing it, you will need to purchase Snow Leopard from the Apple Online Store, unless its original OS was already Snow Leopard (yours was probably OS X 10.5.2 "Leopard"). Snow Leopard costs $20.
Only after installing Snow Leopard can you purchase Lion from the App Store. You will need to call the Apple Online Store again and purchase a download code since Lion no longer appears in the App Store. That will be another $20. You will "redeem" this code in the App Store.
Your MacBook is too old for Mountain Lion.
Total cost: $65 + tax + whatever you already spent.
Tell your GF she was right. Do that now, to prevent further compounding your misery
Thank you John for getting back to me so quickly.
Now, when I am in the disk Utility I see that there is a line under " Mackintosh HD" and then a Label of " Disk 1" and then under that there is another label that says " Mac OS X Base System". What would these 2 labels be used for ? Is that the Recovery Partition?
... What would these 2 labels be used for ? Is that the Recovery Partition?
Yes. The RP is a small partition created by the Lion installer, for the sole purpose of booting your Mac to the point that it can install Lion on your usual boot partition.
Problem is, you can only install it if you bought it, or if it was already installed when the Mac when it was shipped from Apple. In the latter case, no Apple ID is required.
Conceivably, you should be able to use another Mac to purchase Lion, and you can then download it on as as many Macs as you own without having to pay any more. You would use that Apple ID to download it on your MacBook. I have not tested that specific circumstance though.
The simplest solution would be to buy the 10.6 Snow Leopard disk. then erase your hard drive install Snow Leopard. The 10.6 Snow Leopard DVD is in the Apple online store. You can get it for $19.99. You will need to be running 10.6.8 to access the App Store to order Lion. http://store.apple.com/us/product/MC573/mac-os-x-106-snow-leopard
Once you are at 10.6.8 10.7 Lion is still available from Apple. You will have to call Apple Customer Care 1-800-692-7753 or 1-800-676-2775. to purchase it. Then within 3 days you will get an email with a code which you can use to download Lion from the App Store. The price is $19.99.
That way you will be the owner of the OSs.
When you get the 10.6 Snow Leopard install disk put the DVD into the optical drive (CD/DVD drive) and reboot. As soon as you hear the boot chime, hold down the "c" key on your keyboard (or the Option Key until the Install Disk shows up) until the apple shows up. That will force your MacBook to boot from the install DVD in the optical drive.
When it does start up, you'll see a panel asking you to choose your language. Choose your language and press the Return key on your keyboard once. It will then present you with an Installation window.
Completely ignore this window and click on Utilities in the top menu and scroll down to Disk Utility and click it. You should see your hard drive in the left hand column along with your other drives. Click on the drive and select the Erase tab. Set the format value to Mac OS Extended (Journaled) and click the Erase button. After that has finished select the Partition tab. Type in a Name for your hard drive and select how many partitions you want from the Volume Scheme. The usual setting is one partition. Click on the Options button after you've selected a partition to make sure it's set for GUID. Then click the Apply button and after the Partitioning is done quit Disk Utility.
You can now follow the instructions on the install screen