What happens when Google removes a purchased app from Market? Google removes malicious and copyright-smasher apps from Market. And, I think paid apps are equally treated in this case. Fortunately, Google hasn't removed any app purchased by me, yet. So, I don't have any idea.
What happens when Google removes a paid app? Google returns its cost to buyers or not?
Can I continue to use that app with infringing law?  

Another situation: When I purchase an app and do its FIRST installation after even month, the 15-minute refund option is provided. In case of app removal from market, can I utilize the refund option?
From http://www.google.com/intl/en_uk/mobile/android/market-policies.html ,


  Product Removals: From time to time, Google may discover a Product on
  the Market that violates the Android Market Developer Distribution
  Agreement or other legal agreements, laws, regulations or policies. In
  such an instance, Google retains the right to remove those
  applications from your Device remotely, at its sole discretion. If
  that occurs, Google will make reasonable efforts to recover the
  purchase price of the Product, if any, from the originating Developer
  on your behalf. If Google is unable to recover the full amount of the
  purchase price, it will divide any recovered amounts between the
  affected users on a pro rata basis.


From what I can gather from above, it seems that


The app in question will be removed from your device and you will be entitled for a refund. (not strictly a full refund sometimes)
The app fails to be removed from the device and you may not get a refund. (Though I suggest you can contact google in this case)

If the app exists on your device, you can use it any how and it is not under jurisdiction of google anymore.



And answer to you alternate situation, again, yes Google will make reasonable efforts to recover the purchase price of Product and the refund option will probably work.