The SD Card is 2GB (at least the one that came with mine is). The Internal Storage (basically an SD card built into the phone) holds about 7 GB. I put all my music on the internal storage, but you have to make sure the music app you're using can access it. The stock one, Winamp, and Mixzing all can, so that's what I use. All your apps are stored on the internal storage, and the data for the apps can be stored in either place, depending on the app.
If you bought a larger SD card you can put your music and videos on that instead of the internal storage. It's probably best if you keep all your music in the same place (don't split it between internal and SD card).
To tell them apart, look at the sizes in my computer.