Drop to a terminal and run
cat /dev/psaux OR
cat /dev/mouse/0 and move the mouse around. If you see a bunch of data dump to the screen, that proves that the mouse is working. You can end the horrible dump by pressing Control-C.
Next, you need to make sure that /etc/X11/xorg.conf has the correct driver and points to the correct device node (/dev/psaux or /dev/mouse/0).
If that still does not work, you may be dealing with HAL messing up when attempting to autodetect the devices.
Add/update the "ServerFlags" section in xorg.conf with:
sudo nano /etc/X11/xorg.conf
Option "AutoAddDevices" "False"
Option "AllowEmptyInput" "False"
Close out by holding Control and Pressing X. Follow the prompts to overwrite.
Also, you may need to make sure that the following packages have been installed/updated using apt-get:
sudo apt-get install xserver-xorg-input-kbd xserver-xorg-input-mouse