1. As mentioned, any harddrive will work. If you install IDEfix 97 found on Aminet, you will be able to use the whole harddrive, if you install a suitable filesystem, like SFS or PFS3. Can be tricky to set up though. I think the limit for drives on the build in IDE controller is 127 GB (it is on Amiga 4000, haven't tried on Amiga 1200).
As for partitioning; make sure to make a bootable partition that is in the borders of the drives first 4 GB, and with a partition size below 2 GB (don't know why anyone would a boot partition that big anyway, but it's the limits). At boot up the updated scsi.device needs to be installed first, before you can use the rest of the harddrives capacity.
2. No need to towerise the A1200, unless you want to use anything above a 030 CPU. A Blizzard 1230 for instance will give you a big speed improvement, and will allow you to install up to 128 MB of fast ram, and fits nicely in a desktop A1200.
3. As mentioned, modern cardbus cards won't work. If you want to use a cable ethernet card, I have used a 3com Etherlink III myself, but have gone wireless now with a Netgear MA401. As a note for the 3com card; they are not always working straight out of the box, so you might need to install it in a PC at first and edit some of the card settings, before you can use it with the A1200.
As for surfing the net; it will be possible, but the screen size of native Amiga modes sets the limit. Not very pleasant to surf the net with 256 colours at max, and in a screenmode of 400 x 640. It's good enough for downloading archives from Aminet etc though.
4. As with everything else, supply and demand sets the price.
