What You Need To Know About Cameras
Tip 2 - Digital Sensors Small and Large
More than megapixels, the sensor in your camera determines the quality of your images. After all, it is the device that records the scene. Do you remember how photography was portrayed in the Flintstones cartoons, where a bird inside the camera looks at the scene, then pecks it out on a piece of stone? Well, your digital sensor is that bird. You want to buy a good bird.
Without getting too much into the science of it, your camera's digital sensor is basically a wafer covered with millions of tiny photosites (one for each pixel) that collect color and light during exposure and then convert that information into digital form.
Before digital, most professionals shot film in medium and large format cameras to achieve the highest degree of clarity and quality. These bigger negatives (often 6cm rolls or 4x5 inch sheets) provided astonishing clarity and detail beyond what regular 35mm film could resolve. Digital sensors scale in a similar fashion. The size of your camera's digital sensor has a direct effect on the quality of your images.
Small Sensors
Most compact digital cameras (point and shoots) utilize smaller sized sensors, some smaller than a dime. These smaller sensors have a lot less real estate in which to plant their millions of photosites. When these photosites are packed in so densely in tight quarters, the resulting images are more prone to showing noise (similar to the grain in high-speed film). The same scene photographed with a small sensor will show much more noise than a larger sensor at the same setting. The examples below were shot at ISO 200 with a compact digital camera and a digital SLR for comparison.

In addition, due to their smaller size, small sensors require lenses with much shorter focal lengths than 35mm photography. These short lenses have a tremendous depth of field. You'll notice that nearly everything is in focus, front to back. This can be good at times, but if you ever want a blurred background, forget it. You'll never get shallow focus look that a longer lens (on a larger sensor) would give you.
Medium Sensors
Medium-sized sensors are often found in mid-range digital SLR cameras. These cameras often accept the same lenses as high-end full-frame sensor cameras, though their smaller sensors crop in on the image, often by a factor of 1.3x, 1.5x, or 1.6x. This is often a huge benefit on the telephoto end. For example, a 200mm lens on a camera with a 1.5 crop factor gives you the same field of view you'd normally need a more expensive 300mm lens for. On the downside, these medium-sized sensors take away the wide scope of your wide angle lenses. With a 1.5 crop factor, your wide angle 24mm lens is now a normal 36mm.
While the crop-factor of these sensors will reduce your field of view, it is important to remember they will change the depth of field of your lens. The image is only being cropped in toward the middle. So while your 200mm lens may now have the reach of a 300mm lens, it still has the depth of field and other optical characteristics of a 200mm lens.
Large Sensors
The larger photo sensors found in the higher end digital SLR cameras are more expensive. But the payoff is improved image quality. As photos from the 11 megapixel and up cameras began to appear in recent years, side-by-side tests showed that the quality of scanned film had been surpassed by these high end cameras. Yes, that's right. Better than film.
As each generation of camera is released, the technology pushes ahead producing a higher level of quality. Megapixel counts continue to rise, image noise is reduced, and color becomes truer and more saturated. But the physics of light and lenses are locked into place. Technology can't yet overcome the laws of physics. Without divine intervention smaller sensors will never be able to replicate the look of larger sensors.