There's no simple answer - it depends on a lot of different factors, the most influential are probably the quality of the scaler in the source (i.e. DVD), the quality of the scaler in the TV, and the TV's native resolution.
Every HD TV a) scales the signal to fit the native resolution of it's screen and b) converts interlaced signals at 50hz (or 60) into 25 frames per second (or 30) progressive image (de-interlacing).
The questions when watching standard def material are a) would the scaler in the source do a better job than the one in the TV? and b) would the source do a better job of de-interlacing than the TV? Probably only something that you can find out by experimenting. If you use the source to scale then common sense would suggest that you set the output resolution to as close to the TV's native resolution as possible (i.e. so that you don't scale at the source only to leave the TV having to scale again to fit the image to the screen).
When watching HD material you might take the same view as above and set the source to allow the TV's scaler to do the minimum of work. Alternatively you might take the view that you want to supply the source material in it's purest form to the TV and trust the TV to take care of the rest.
I've got an HD-ready pioneer plasma and I have Sky HD permanently set on 1080i for everything, as is DVD upscaled by my Blu-ray player. Blu-ray material itself is fed as 1080p. I settled on this because I think that HD channels look slightly better fed in 1080i (skyHD native resolution) although the slight trade-off is that the SD channels look ever so slightly worse, but i'm not aware if there is a way of setting a different resolution for SD material on Sky HD. I really couldn't see any difference in quality on the DVD side between 1080i and 720p, so I set the blu-ray player to 'auto', which ends up being 1080i. Blu-ray is best left in it's native resolution to retain the original 24 frames per second signal, so 1080/24p.
If you've got a full HD TV then it's a no brainer - set all HD material to 1080 (i or p - preferrably p if the material/source allows) as that fits the native resolution of your TV. For SD experiment to figure out which scaler is better - the source or the TV. If it's the TV then set the source to output only the native resolution of the source material.