The drop down menu displays items in the site tree that are of type "Page (menu item)". You can also tell the menu to render other types of documents, such as folders, news items, blogs... but you must specifically tell them menu to do so under the "Document Types" attribute.

With regards to the sub-menus, every navigation web-part has an attribute called "Path". In the path field, you can select the "starting path" of a menu. For example, on the Corporate Site, there is a "Products" page with three sub-pages ("Cell Phones", "PDAs", "Laptops"). When you click on "Products", you will see a left nav which ONLY displays the 3 sub-pages. This is because the "Path" attribute for that menu is set to "/Products/%"... which tells the menu to show all pages under the "Products" page.

If you do not want an item to appear in the menu, you can select the document in the site tree and go to Properties -> Menu -> Show In Navigation ... and uncheck the box.

Cheers
~Ryan