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So I install two Windows 7 VMs through VMware fusion 4. The desktop resizes very nicely in the first: Windows senses the resizing and uses smaller icons.

In the second VM Windows simply magnifies its desktop to a rather ugly one: the desktop uses more real estate, but it's just a magnified image of a low-resolution desktop.

I'm not aware that I have changed any setting related to the desktop. How can one intentionally get the former behavior?

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Sounds like you might not have VMware Tools installed in the second VM. Do you see the VMware Tools icon in the taskbar tray?

enter image description here

If not, you can select "Install VMware Tools" from the "Virtual Machine" menu (mine says "Reinstall" as I already have it installed)

enter image description here

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