Here are a few reasons why pixelation may occur:

Video will get pixilated in the timeline if the timeline stretches the videos to the project's dimension. You are right in selecting the "Use the Dimension of the first Media File added to the Timeline" option when creating a new project. Since you are combining both JPEG and MPEG files on the same timeline, possibly of different widths and heights (dimensions), you may end up with the project's dimension being larger than most of your videos in the timeline. In this case, the timeline will stretch the videos and will result in pixelation.

Video Edit Magic's Make Movie is independent of the project's dimension. You can select a width and height that is different from the project's width and height. Thus, the video will get pixelated if you make movie in a larger dimension than the original video.

In other cases, stretching highly compressed and low quality footages causes more pixelation than stretching high quality footages. The choice of output formats, video compressors and Quality during Make Movie will also influence the amount of visible pixelation.