Try updating to 10.6.4 via Software Update from the Apple menu.
Your built-in iSight should work fine... Are you trying to use an external camera?
If you open iMovie and choose File > Import from camera...
and switch to the Built-in iSight as the source camera, does it work?
If your iSight camera is not working I'd recommend taking your MBP to your local Apple Retail Store and getting is checked out.
Hi Straight Shooter,
Where is the original image? In fact you don't need to place the image in a particular folder to set it as the Desktop Image.
Simply right-click on the image file in the Finder and choose "Set as Desktop Image" from the drop down menu.