Transparency options are all greyed out? I'm using the nodes in Internal, and the problem is that the transparency options in the Material tab are blanked out. The Image Texture I'm using has a part where it's transparent!

Here's my setup and the Transparency options greyed out.



Here's the image texture in question (The bottom left part, which is a skirt, is transparent)



And here's the render.



I've connected and disconnected the Alpha part of one material and the other to the output node's Alpha and neither makes a difference, surprisingly.
I didn't realize you moved this to a new question...try this:

In the Material, make sure you select 'Transparency' with Z Transparency under Render Pipeline Options. 



Also under 'Options', turn on Face Textures and Face Textures Alpha. Under the Texture itself, make sure 'Use Alpha' is checked in the Image section. 



Oh also connect the Alpha from the Material to the Output as before.