You can't play PS2 games on your PSP, only PSX.
Go to
http://www.dark-alex.org , get the latest firmware, then download alcohol120% and turn the 3 cds of ff7 into ISO's. After that download PSX2PSP and use it to convert the ISOs into eboot (the psp format), and make sure you have the same save ID for all of them (you can just make it up, just make sure it's the same one for all 3 cds or you won't be able to carry your save between the different cds when you have to "swap" them..)
That's pretty much it, DA's website and his firmware readmes explain everything else.
Just IM me if you're getting stuck though.