Quarrels are used by crossbows. They can also be used by a later version of the Omnigun (an automatic improvement as you level up).
You merge items to make gadgets. In inventory I pick up the new gadget item to check, click on merge, and then click all other gadgets in inventory. Some you have to be advanced in engineering to use (the message is different than you can't merge those gadgets, I think it says so-and-so can't merge them). Engineering goes up with item use. I boost it at every level to the max.
Hope this helps!
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