mp3 in" media", you can also put videos here which have been made for mobile.
"Music" is only for the music store koz files.

Never use windows media player for transferring, it seems to do some strange stuff.

As for reducing the size, you need to use something that will spit out "aac+ sbr" files and encode at 40kbps which will give you a nice quality and use up little space. You should then easily get the files to be about 1.2 mb each.
(this is all the music store files are, this is actually the format they use but with added drm.)
Maybe someone here can point you to an easy encoder link? I have compiled one but it's such a pig to use.