I'm a ballet mom, and have certainly spent my fair share of hours in the studio lobby. My girls attend the student division of our local professional ballet company's school. The way our studio works is that children who are 5 and under are in "creative movement" classes. At this age, they are really too young to have the coordination and strength required for barre work, so really they focus on gaining coordination, following directions, and paying attention. When they are ~6 years old, they begin with Beginning Ballet, and that curriculum spans 3 levels (generally each level takes a year, but it can vary from child to child). After the child has mastered the BB3 curriculum, they move on to level 1 (that is the start of the "student division"). Level 3 is pre-pointe, and Level 4 is beginning pointe. From there, levels 5-7 are the "pre-professional" division - many of these girls go on to dance with professional companies, and level 7 girls are typically home-schooled due to the extreme time commitment required. (They are at the studio 30 hours per week, sometimes more.) My oldest is in level 3, and spends about 12 hours per week in class.
All of that being said, kids would typically not be in Level 1 at 7 years old (although it does occasionally happen for kids who are extremely coordinated and can pay attention for the entire 1:15 duration of the class). If they are putting your 4 year old in Level 1, I think you need to find a different studio. She's still a little one, and should be in Creative Movement for a few more years to build her coordination and strength. With ballet, even girls who are very advanced can find things to work on in lower-level classes, so there is no harm in young children being in the same class a few years in a row. Unlike in school, in ballet, kids do not always move ahead one class per year, and that is okay, and totally normal!
In terms of what they wear to class, generally speaking, you want them to be in a solid-color leotard, pink tights (no underwear underneath, it looks lumpy), leather, full-sole ballet shoes (no canvas, no split-sole - leather full-sole strengthens the feet). Even if that is not required at the younger level, I would still have your kids dress in proper ballet attire. Dress for the job you want, not the job you have, right? ;)
The other thing I'd mention is that if you really live in Austin, and your girls love ballet, send them to the ballet school at Ballet Austin: http://www.balletaustin.org/academy/ We have been at a few different studios throughout our travels, and by far the best ones are the ones that are affiliated with a professional ballet company. The teachers will be top-notch, your kids will develop proper technique right from the start, and generally, these schools really want the kids to love the art form, so they keep things very positive and fun. (Also, your kids can try out for the Nutcracker, and other shows when they're old enough, which is pretty much what my kids live for ;).
Anyway, I hope that helps! My oldest is in Summer Intensive this year - before you know it, your kids will be, too!