Your
chipper output is actually into the same chamber as the shredder on the engine side of the flywheel. The knives cut chunks off the end of the branches you're feeding which go through the slots in the flywheel, and wind up on the same side as where you feed the shredder. The J-hammers are beating the chips up just like they would anything you put in the hopper.
Mine (a 17 year old Murray) is a little different. It uses flails at the outer edge of the flywheel (at a 90 degree angle from the knives) which pass through the screen/baffle that the others are talking about. That baffle is removable for larger chips, but they're really not much larger and instead, I get a lot of long twigs from brush, too. I have a lot of ironwood, hackberry, elm, and birch, and all will clog the little Murray up pretty quick with the stringy bark if I don't take the baffle out.
Most of the chip size will be determined by the amount the knife edge sticks through the flywheel. The gap between the knives and the anvil is mostly just to keep the knives from hitting the anvil which is where the stick is pushed while the knife is chopping a chunk off. But, if you increase that gap, the knife will have a harder time shearing off dryer wood. It simply won't cut as well. The closer the anvil is to the blades, the better they'll cut. Until it gets too close and the knives hit it. The anvil on small chippers like these usually isn't adjustable, and is usually built into the
chipper inlet chute. The angle of the stick to the flywheel will affect chip size some as well as it will cut closer with the grain as the angle decreases. But, since the chips go into the shredder chamber before coming out they're gonna get chopped up more by the J-flails.
I don't use my little Murray for chipping anymore because of the severe beating it gives my hands as well as having to cut the brush up more. But the shredder's still useful for rechipping the output from my WC-68
chipper if I want compost filler. I feed it with a pitch fork and don't get the high frequency violent vibrations to my hands feeding the shredder. It is especially unkind with dry brush.