I've just spent a day trying to figure out how to get the paragraphs to work properly. It seems it just affects Firefox, IE inserts the full <p>&nbsp;</p>

After playing around with a multitude of configurations in tinyMCE I think I have the solution.

In
orca/layout/base/xsl/canvas_init.xsl & orca/layout/base_en/xsl/canvas_init.xsl

locate the line that says :
entity_encoding : "raw",

and replace with

entity_encoding : "named",

This fixed see more the problem for me. You may have to alter the same line in other scripts where the tinyMCE editor is used, but I haven't looked yet.