"While running this session we can select the item we want to run MRP for. How does this item selection work? Can we select a top level part number (which is an MPS item) and will the MRP sesssion then generate MRP for all the components below it (if the components are MRP items)"
MRP can not be run against the top level item that is an MPS item.
"What if I select a component (which is an MRP item), will it generate MRP for the rest of the components (which are MRP) in the BOM"
If the MRP item is a purchased item, MRP will only be generated for this item. If the MRP item is a manufactured item , MRP will be generated for this item and all subcomponents in the BOM of this item.