To answer the original question, any system employing 32-bit addressing will face a theoretical limit of 2^32 (or 4,294,967,296) distinct addressable memory locations. Since the addressing granularity for PCs is one byte, that means a limit of four gigabytes. Typically some of this space is reserved for other purposes, such as mapping onto hardware registers, leaving less RAM functionally accessible. So most users with 4 gigabytes installed will see approximately 3.5 of that available.
Your cousin might be misunderstanding the distinction between physical and virtual memory. Even plain vanilla 32-bit Windows XP running on a plain-vanilla 32-bit CPU can access very large sums of virtual memory. Although an individual pagefile in such cases is limited to 4095 MB, it's possible to employ multiple pagefiles to achieve the necessary total. The PAE switch can also be employed to ease size restrictions if a CPU with the necessary support is installed.
Microsoft's own support can provide some insight into how this can be made to happen.
So Windows does see the pagefile and system RAM as 2 separate entities, interesting.
Well, there are multiple layers involved here. On the physical level, Windows (really any OS that uses virtual memory) will see the pagefile and physical RAM as the distinct entities that they are, because it has to manage the transfer of data between the two. But the virtualized space they form when united is treated as all the same thing from an application's perspective, with the main distinction being whether or not accessing a particular virtual address triggers a page fault. If it does, that means either the address is invalid or that it resides in secondary storage and requires loading into physical memory in order for access to proceed.
As for turning the pagefile off, well I ran for nearly a month on just my 2 gigabytes of RAM with paging disabled just fine. It wasn't until I played the Witcher demo that my system complained I was running low on virtual memory. Crysis, World of Warcraft, UT3...they all ran just fine without it.