Imaro
Legend
All the bits about dragons that the PC's may or may not encounter seems a bit odd to me. If you dont intend the PC's to EVER encounter the dragon, why bother mentioning it to begin with? Someone earlier mentioned the old Dungeon rule of 'Dont do more work then you have too'. This harken back to Chehkov's Gun. If you mention something, it should be important later on, else you shouldnt waste time on mentioning it as it doesnt matter.
Are you talking about a sandbox campaign here? If so the DM doesn't decide when, how or why the PC's interact with something... he only determines what is there to interact with and where it is. Now there are two types of DM's who create a sandbox, the first will put up arbitrary restrictions and contrivances to make sure you only encounter level-appropriate encounters (honestly this isn't really a sandbox IMO but is more the illusionism Cadfan speaks of earlier)... the second type will allow his players to explore whatever they want but won't arbitrarily try and stop the PC's from biting off more than they may be able to chew (though if they put the effort forward he will inform them about the challenges they are seeking out).
Think of it like an amusement park where, you have various rides that one can experience. With the first type of DM running the amusement park there are guards at each ride and if you don't meet the age/height/etc. requirements you are not allowed on that ride...period. How, when and why you get on a particular ride is up to you, you're just extremely limited in what rides are available.
With the second type of DM running the game, There might be signs by the rides telling you the recommended height/age/etc. but no guard is going to forcibly remove you or block it. You can make what some might consider a bad choice (get on a ride that is more than you can handle and end up throwing up) or a relatively safe choice (hey look the merry-go-round) you could even be the type that risks the supposed "bad choice" and walks away with nothing more than a grin and an adrenaline rush.
Finally you also get rewarded foir each ride you take, the scarier the more you get... only in the first DM's amusement park you get a good average but no high or low prizes... while in the second if you are willing ot take bigger risks you can garner bigger rewards.