first off, I have the free version, and am running gamestudio on a 4 year old Dell Inspiron 1545 laptop just to clear up system specs.

I am trying to work on lighting and setting the mood in games however, the dynamic lighting is very wrong. I know how lights work in real life however, they don't work this way in GameStudio. Take a look.

http://youtu.be/KyukKON7sg4

The light on the wall should be constant and following the ball (which is emitting the light) but its not. What am I doing wrong?

thats because it's per vertex lighting (the light color / brightness is calculated per vertex and 'smoothed' between them).
Use per pixel lighting instead, but you need at least com for this (and a per pixel lighting shader, of course)

But since you're using the free version you can only increase the poly-count to make the lighting smoother but the quality won't be as good as per pixel lighting...

Oh and... "I know how lights work in real life however, they don't work this way in GameStudio."
All lighting calculations in games are just a bad fake of real lighting.