Kizza
As Fordsy has already stated - it's all about hydraulic ratio. A smaller M/C has the ability to apply a larger pressure for a given push which is transferred to the brake calliper pistons.
Crunching the numbers for the 7/8 master with a push on the pedal of 100lb (ignoring pedal ratio).
Area of the piston (0.875)^2*3.14 = 2.404 sq inches
Pressure 100/2.404 = 41.59psi line pressure.
Using a 5/8 (0.625) master cylinder
Area of piston (0.625)^2*3.14 = 1.227 sq inches
Pressure 100/1.227 = 81.53 psi line pressure.
Hope this helps demonstrate why the smaller MC gives the greater line pressures available to the brake calliper. Assuming the same brake calliper is used in both of the above scenarios then the smaller MC will give the better braking effort.
The pedal stroke will also be greater as both the 7/8 and the 5/8 cylinders will need to move the same volume of fluid to operate the brake calliper piston. This is where pedal ratio comes into play to also boost the line pressure by effectively multiplying the force applied to the MC piston.
With a pedal ratio of 6 : 1 the force applied to the MC will be 600lbs - which effectively multiplies the line pressure by the same factor.
A compromise needs to be made between pedal ratio and the required sweep of the pedal to acieve the full stroke of the master cylinder. Make the pedal too long (to get better ratio) and it will hit the floor before the MC has reached it's limit. This can also happen if the MC is too small and cannot supply the calliper with sufficient fluid to operate correctly.