clientY is the mouse's vertical position compared to the window.
pageY is the mouse's vertical position compared to the page.
I've made a handy dandy Paint PNG to illustrate the difference:
In your case, it makes no difference. You said that the page's content would never be longer than the screen, so either value will work. (I originally suggested clientY because I didn't know you were using jQuery, and Internet Explorer doesn't support pageY.)
As to your second question, I don't really understand. Changing the height of the container is as simple as messing with its "top" and "bottom" styles until you get it where you want, but...
Do you want the indicator to line up vertically with the mouse, but only if the mouse is within a certain section of the page? Then you'll need to add a check to your mousemove listener: Don't change the indicator's "top" if the pageY is less than the container's "top" or greater than its "bottom". And when you do change the indicator's "top", you'll need to adjust for the container's "top"... If you mess around with it, you'll see what I mean.
Do you want the indicator's position to be proportional to the mouse's position? For example, if the mouse is about a third of the way down the page, do you want the indicator to be about a third of the way down the container? If so, then you'll need to compute pageY over the full size of the page/window, multiply that by the full height of the container, and use that for the indicator's "top".
Did any of that make sense?