Why use dialogue here, instead of narrating Old Man Warner’s thoughts to the reader? When would one use the former, and when would one use the latter?

I think this is a stylistic decision by the author. Shirley Jackson wanted to use direct character representation in the form of dialogue to present an idea. Old Man Warner's lines represent our only clue to the reasons behind the lottery. He also represents the inability to change and evolve. Jackson skillfully presents the old man's character in a way that the reader can almost hear his voice: the voice of stagnation and fear of change.