Yes, dvd's are 720x480 max. (576 pal)
That's ridiculously low, considering your computer can easily interpolate that image to 1920x1080 (or equivalent, depending on aspect ratio)
I would have to agree with protovision - a different program would work better for you.
You should be able to play it in any player now that you have the cyberlink codecs from the powerdvd installation - they're able to decode the encrypted dvd and play it in (theoretically) any program (assuming there aren't any restrictions by cyberlink).
It is most likely an HDCP issue. IIRC, something else mentioned on these forums or another liked to give that message when trying to output HD res to a non HDCP device.