As you have established, you have downloaded WUBI.
The "Installation size" options lets you decide the amount of space you want to "give up" for WUBI. That is the space wubi's Ubuntu install is able to use.
Wubi creates a disk image (loopmounted device) on your host system in/on which Ubuntu is installed. This can be compared to a kind of "safe partition" on your system.
This means the space you reserve for Wubi is not usable for your host system any more (in fact it is not even accessible from within the host system without external programmes. Ubuntuforums: Accessing Wubi Disks from Windows , AskUbuntu: How to open wubi's .disk files under windows?). Windows 7 (any Windows for that matter) will count the space you reserve for your Wubi install as occupied since Wubi just creates a file of exactly the amount of space you specified (let's say 20 GB) on your host system's harddisk, regardless of the space actually occupied in your Ubuntu Wubi system.
Apparently, there are ways to resize the wubi virtual disk (Help.Ubuntu: ResizeWubiDisk, Ubuntuforums: HOWTO: Resize the WUBI virtual disk).
You need to reserve enough space for Wubi to install Ubuntu and - if you want to use it properly - to install programmes. Additionally, you will want to have some space for documents etc.
So I'd recommend no less then 8GB of space, maybe even as much as 20GB if you can spare that much.