Too many clients connected

Hi All,
I am sorry if this was already discussed. I am new to the world of
postgressql and was experincing a problem for which I need help of an
expert in this lists.
We have devloped a site(asp.net 1.1) for which we have used postgresql 7.4
as the backend database. When the number of connections increases we are
getting an error "Too many clients are connected" we then adjusted the
number of connections from the initial value of 30+ to 200 it get solved
initially but we are experincing the same problem again. Before adjust the
connection settings I would like some one with answers to the following
questions.
1. How does postgresql handles database connections?
2. Under what situations does this error "Too many clients connected" is
thrown?
3. Should we increase the max connection settings to say 1000 if yes what
about the PC configuration that is needed for it. We are currently running
the postgresql in a linux box with 1 GB ram and 2GHZ xeon processor.
4. is it advisable to upgrade postgresql to 8.0?? will it solve this error
once and for all.

Thanks in advance

regards
venki