I've always pretty much thought of Mario to be similar to Mickey Mouse. Mickey's been around for 80+ years and has always been about the same age, or at least the same maturity level. For Pete's sake, he could at least marry Minnie after 80+ years of dating! (No pun intended with the Pete reference; those of you who know the old cartoons will get it).
We get the nephews of Mickey and Donald in the Disney universe, but in the Mario universe we get the dreaded baby characters. It was never really a problem for me until they started putting Baby Mario in the same games as adult Mario. Baby Mario in Yoshi's Island made perfect sense. Therefore, I think only a few possibilities exist:
1. There's some sort of anomaly in the time continuum of Mario games, where two Marios can exist at once, yet one's smaller. Imagine yourself and your five year old self alongside you as a kid, and I don't mean as an actual son or daughter of yours--it's you, but when you were five.
2. These are nephews of Mario and Luigi, sort of like how Mickey's nephews look exactly like him (same with Donald Duck's). Somehow, they've got the same names (I think one of Mickey's was Morty...and I know Walt Disney wanted to call hm Mortimer...so it's not too far out of the question).
3. These are actual children of Mario and Luigi. I see this as the least likely since, if I remember from the more recent games, there's no definite answer as to whether Mario and Peach are actually dating. (Of course, I haven't bought a new title in a while, so things may have changed).
I think it's basically just an excuse to get more characters out for the sake of merchandising, overloading the rosters in multiplayer games, and bringing back a character from games in which Mario is a baby. Trouble is, most people actually didn't like Baby Mario back in 1995 because of the crying!!
The presence of the babies has always annoyed me a bit since there was never an explanation. Plus, we now have baby versions of Peach, Daisy, and even Rosalina all at the same time. One question--WHY?
In regard to Rosalina, I doubt she's got any relation to any of the other characters. Nobody knew who she was until Galaxy, and I think they're putting her in more and more games because of the lack of female characters compared to males.