Stupidity: Xander really has no reason not to believe Buffy when she tells him that Miss French is evil/a giant bug. There is an in-universe explanation of pheromones affecting him, but that's flimsy at best. He's already dealt with vampires and witches and body-swapping, and there has already been a murder around the time Miss French showed up... the fact he doesn't believe Buffy seems very forced and contrived.
Stupidity: The master goes through all the trouble of making Luke the vessel so Luke can go and kill several people and risk getting the attention of the slayer, when all he had to do is have his minions go out and kidnap a bunch of people and bring them to him and he could've fed off them himself.
Chosen answer: Angel is saying that he is still jealous and Buffy recognizes that this is his way of saying he wishes that they could be together. That is why they both smile.