System 7 will not run on that Mac. You need OS 9 or OS X (preferably 10.4).
http://www.applerescue.com
You can find some great prices on Mac OS X there.
As for USB keyboard and mouse, you can use any USB keyboard and mouse. Doesn't have to be specifically from Apple. Just be aware that the Windows key and the Alt key will be the Command key and Option key, respectively. Also, Mac OS X supports mice with more than one button.
Where did you get this Mac by chance? Sounds like this seller gave you a clunker for a Mac.
