MacBook – “Contextual Menu Items” folder missing on the Mac.

The blinking folder icon indicates that the computer can't find a valid startup disk. Based on the tests you've performed, it may that one or more critical files was removed from the drive, but the screwed up permissions are indicative that something is screwy. I would reinstall the operating system.

If there are files on the disk you want to save, copy them off of the drive onto an alternative volume before installing the OS.

If I understand your question correctly, you're attempting to reset the permissions on a user's home directory. This is easily accomplished by resetting ACLs on the desired home directly by using the Reset Password Utility in the Recovery Partition:

1. Restart your computer from the recovery partition (if running Lion) or the gray disk (if not running Lion).

2. Open Disk Utility and run a permissions repair on your startup volume. After this is complete, close Disk Utility. We're doing this just for good measure.

3. Open Terminal from the Utilities menu. Type in resetpassword and select your user account (NOT System Administrator/root) from the drop down menu.

4. Click the Reset button at the bottom of the window in the Reset home folder permissions and ACLs section.

5. Quit the Password Utility and go back to the main recovery screen.

6. On your keyboard, hit ⌘ + Q and restart your computer. It's very important that you don't hold down the power button to exit the recovery session, or the ACL reset won't occur.

Good luck!