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Suppose you want to store your photos at some lower resolution, let's say about ~1 MB large.
You own a camera able to make photos at 5 MPix and more.
And, you want to have the maximum quality at the smaller size.
Would it be better to make a photo at highest resolution and then resize it with PC software (with a good filter of course), or to directly set the camera to make photos at 2 MPix only?
Downscaling a larger image on computer is almost certainly going to produce a better result. This is because resizing an image is very processor intensive, and there is a difference in quality between the various resampling algorithms (e.g. Lanczos vs Bicubic). Getting a 5 MP camera to produce a 2 MP image is going to cause the camera to perform the resizing and this is bad for 2 reasons: a) You can't control what resampling algorithm is used and b) The camera is always going to have a weaker processor than your computer so will inevitably use a resampling algorithm that's optimized for speed not quality.
So if quality is important, do your resizing on the computer.
Philip has it spot on there, resampling on a computer will give you more control and access to better resampling algorithms.
There's another reason not to select a smaller size on camera and that is if you download your photos and find one that is really good you can keep it in high resolution. If you set your camera to 2 megapixels there's no going back!
Given the choice between a 5MP and 2MP camera, shooting the 5MP camera and resizing will also give you better image quality (all else being equal) as you'll have better colour resolution and less aliasing.
It probably doesn't matter very much.
The computer has an advantage because it can bring more processor power to bear. You can use more sophisticated algorithms, including tailoring the right one to each image. (And, as Matt Grum points out, you have the larger version available if you change your mind. This is probably the most compelling reason to go this route – it's hard to guess your future needs.)
The in-device conversion may have other advantages, though, depending on how it's implemented. First, it can do its downsizing on the raw sensor data rather than working on an already-converted JPEG. That avoids saving in JPEG more than once (which, given that you're discarding detail, isn't that important in this case), and allows the camera to do the downsizing as part of Bayer de-mozaicing. This might give a minor quality improvement. Second, the sensor may do a hardware-level pixel binning, which decreases read noise when shooting at a lower resolution.
But those advantages are highly implementation-dependent. I think the best thing to do is actually take some images and compare. If you can't tell the difference, go with whatever is easiest. (Or take the advice of storing the larger versions somewhere after all, just in case.)
I would add that taking high resolution pictures on the camera allows you to crop and resize the picture on your computer. For instance you could keep half of the area of your 5MP image and still save it in 2MP if you took a shot too wide.
