Controlling a 49 two-color LED matrix
Disclaimer: I don't know the "right" way to solve this problem.  But I'll present my thoughts on the approach to solving this, and people can add comments and up/down vote to hopefully massage this into an answer that helps you out.

The first thing I do is to think about the most brute-force solution.  Let's assume your two colors are red and green.  You'll therefore need 49 red and 49 green LEDs.  You need to connect power and ground to each, as well as a current-limiting resistor, but let's only focus on connections for now since you want to use an Arduino.  The cathodes for all 98 LEDs can be tied together to ground, and the other 98 can connect to your microcontroller.

Clearly, this doesn't work because you wouldn't have enough digital outputs to individually address each LED.  And you want to change the brightness, so you'd also need several PWM outputs.

Footprint/aesthetics-wise, if you can get a bi-color LED that has the two colors you want, I would try to use one of those instead, and will assume that direction for the rest of this "answer".

Now we have a design with 49 bi-color LEDs, with all cathodes tied to common ground.  You've got to now think about the 7 discretely-colored and brightness-controlled rows, and individual on/off control.  When I think of brightness, my first approach is to use PWM.  I think that technically this isn't the "right" way to do it, but I don't know how to make current sources, so PWM is the route I usually take.  Let's assume that you have 7 outputs reserved and you are going with a 100% software solution, likely imprecise, i.e. you can't just set the PWM duty cycle in a register and automatically have the output toggle for you.

The next issue to look at is the 49 individual outputs for controlling each LED.  It's a little crazy to try to source a micro with that many outputs just to do the LEDs, and impossible on an Arduino, so for this I recommend looking into serial-in, parallel-out shift registers.  The last time I used one of these was for a scrolling LED matrix display in school, and it had 16 outputs.  By now, maybe they have larger ones.  But with 16 outputs, you only need 3 shift registers + 1 separate, or 4 shift registers, and one of them will only be connected to a single LED.  Kind of a waste.  Your software will be responsible for taking the pixels that you want to display, converting them into a serial stream, and then strobing the input to the shift register accordingly.

But what about the bi-color LED?  You need two connections to each LED.  At first, I though you could solve this with a simple logic circuit, so that turning a single output on or off results in a different color.  But obviously, you want to also have a third state -- OFF.  :)  So basically, I think you can't get around having two "outputs" per LED.

Perhaps the best way to solve this is to then use two sets of shift registers -- one set of 3 (or 4) shift registers for one color, and another set for the other color.  These shift registers need to have their parallel outputs set in synch, or you'll get some color mixing when both colors turn on simultaneously.  I don't think this is going to be an issue, though.  Just stream your serial data into both sets of shift registers first, then call one function that latches the bits (nearly) simultaneously.  I think you'll also need extra buffer ICs or transistors for these extra outputs.

At this point, we have some ideas for solving the brightness control, color selection, and limited I/O capability of the Arduino, but we haven't tied it all together with an LED driver.  LED drive capability can be handled by transistors, or a buffer IC that sources enough current.  If you want to PWM above an LED's current rating (which I learned is acceptable within reason), then you'll probably have to go with discrete transistors, or maybe an IC like a ULN2003A.  You only need one per brightness-controlled row.  Again, PWM is controlled by the Arduino via a digital output and software.

So how does everything stick together?  Well, I think the way I'd do it looks like this:


tie the outputs of all shift registers to one input of an OR gate
tie the PWM outputs to the other input of the OR gates.  You'll have an OR gate per LED and color, so that's 98 OR gates, and you can find ICs with 4 gates per chip.  That's still a lot of chips.  Sorry, maybe someone else can suggest something better.
the output of the OR gates goes to the inputs of the buffer IC / transistors
the outputs of the buffers go to their respective LED legs


Phew.  I know this isn't the most optimal solution, but hopefully some of the things I've brought up will help you out.  I also hope that more experienced members here can comment on ways to make this approach better.