What's the best way to spend the 25k souls gained from killing the Gaping Dragon? Is there some killer item I should buy while I've got the souls, or should I just dump them into leveling up?

Also, is the Dragon Kings Great Axe still a good weapon by the time you get your STR high enough to be able to use it?

I just leveled up with them.

I can't speak to the axe, but as far as spending your souls, it generally depends what kind of leveling you have been doing. There are really no "killer items" for purchase at that point, so personally I would either just get some more levels, or buy some spells if you're going that way, or upgrade some gear if you want... it never hurts to upgrade your weapon to at least +5 if you are comfortable with it.

I've been using the Drake Sword, so can't upgrade that unless I have a Dragon Scale, correct?

I've mostly been doing melee, just started using spells recently. So, I'll probably just up Endurance, Vitality, and Strength.

Also, can you kill the merchant right in front of the Blighttown door and take the stuff that he's selling?

I've been using the Drake Sword, so can't upgrade that unless I have a Dragon Scale, correct?

I've mostly been doing melee, just started using spells recently. So, I'll probably just up Endurance, Vitality, and Strength.

Also, can you kill the merchant right in front of the Blighttown door and take the stuff that he's selling?

Cres of Artoias or whatever to open up the forest sold by the blacksmith near Sen's Fort.

If you kill the merchant leading to Blighttown, you wont be able to buy boss armor later down the road.

Edit: also don't waste dragon scales upgrading the drake anyway, there's a much better dragon sword thing later in the game, if you do intend to use the scales for weapon leveling, and not increasing your rank with dragon cov