Firstly, photoshop allows you to work with layers. Think of it like stacking transparent sheets, like they used to do for making cartoons...a long time ago. You will see whatever is on the top layer...and if the top layer does not cover the whole canvas...you will be able to see the layer or layers below.
The real power of Photoshop is that you can make adjustments to individual layers...or even parts of layers.
So to make an image like that, you would make a copy of the background layer, then shrink it. You could make adjustments or apply effects to either layer individually, to make it look like the sample.
There are several ways to make a color photo into a b&w. Try a search, or Google it.