You miss two things:
i. The length of rope does not change. When the hanging block goes down the vertical piece of rope becomes longer by dL (shown in blue). The horizontal piece becomes shorter by dL, so the block 1 slides to the left by dL. The speeds of both blocks dL/dt are the same
with respect to the big block. The velocity components: negative velocity of block 2 involves negative velocity of block 1. If block 1 would move with speed v
1' to the right, block 2 would move upward with the same speed, so again, v
1'=v
2y '-
with respect to the big block.
ii. We are in the frame of reference fixed to the ground. In that frame of reference the big block moves with velocity v
5 in horizontal direction. With respect to it, the horizontal velocity of block 2 is zero, so v
2x=v
5.
If block 1 has velocity v
1' with respect to block 5, moving with velocity v
5, block 1 moves with v1=v5+v1' with respect to the ground. (Consequence of Galilean transformation
http://psi.phys.wits.ac.za/teaching/Connell/phys284/2005/lecture-01/lecture_01/node5.html) The same is true for the accelerations, dv/dt.
ehild