In the merchant area, north of the poor area... there's a merchant in a building at the very north of the merchant area, i killed him (it didn't hurt my rep) and i went into his back room and found a dagger, just called "Dagger" that gives me amazing stats... i average 2-hit a normal level 40 monster, but this won't hurt my game? killing a npc in all...?

Was the house north west or north east in Ars Magicana?
For the north west house, paying the poet outside to recite some poetry will bring the mage Kistandalius out of his shop, which will give you a brief one-time opportunity to get into his back room and steal the dagger and a random spell book. With the north east house (the smith Geoff, IIRC) you could also have left a teleporter stone in his house, and returned that way when he was outside.

Killing either merchant is not going to hurt your game, except for the loss of a merchant. Kistandalius sells charms and spell books, while Geoff sells weapons and tends to have a lot of gold (useful when you want to sell off loot).

Most or all of the essential NPCs are protected from dying, though you may stil be able to break side quests by killing off certain NPCs.
The patch added protection to more NPCs, though you may have a release already updated to the latest 1.0034A version, as shown in the bottom right corner of the main menu. The DVD version is already updated, and the patch (designed for the CD version) should not be installed.

I killed Kistandalius, also... how much farther in the game do you go after the Council of Seven? if the average person finishes around level 50, and i'm only level 36 and i'm working on that quest now...

Have you done everything else besides the council quests?

There is a 5 level bonus when you enter the wastelands, and an item that gives a level bonus in the bee/wasp garden (during the imp council member quest), so before entering the wastelands most people are in the high thirties to low forties (45 is about max, if you do everything and delay the level bonuses as much as possible, to get the most experience points).

The wastelands are about the last 10% of the game, though much of it can be skipped if you head straight for the areas you need to get to.

I've done most of what I can do...it seems weird that i'm mid thirties though. On average... after the council, how many hours of gameplay is it?

Finishing the council quests should bring you up another couple levels, or more.
Have you used your wish yet, from the Wishing Well?

After the blessing ceremony, the wastelands take about 5 to 10 hours to complete, depending on how much of it you explore. If you hurry, you might be able to finish it in a couple hours, or so.