I cant recommend too many spefic places as I dont know the area well enough to know if they are worth recommending, except one place: Its either number 27 or number 17 (the stall with wooden block pictures on the wall) on si fang jie (in the old town). They make a clay pot rice dish with local ham and some sort of sauce that is out of this world. Feeds two for 6 RMB.
We tried the famous Na Xi place (sorry name escapes me) next to Ma Ma Fus and the food was good, but the service was terrible and prices were ridiculous. (RMB 120 for four). Be prepared to find insects, albeit edible ones, in you soup.
The old city has excellent street foods, be sure to try Ba Ba (I recommend the ham or salty version), deep fried potatoes, and something resembles French fries but are coated in a spicy ma sauce with cilantro. Excellent.
Lu Gu Hu
Is lu gu hu worth the trip from Li Jiang? I would answer an emphatic yes but get out of Luo Shui ASAP and move on to Li Gen Dao its is so much better. Its only twenty minutes further up the road and a light year away from the crass commercialism in luo shui. Try to get invited into one of the traditional Mosu homes, if you walk out to the island that is connected to the mainland by a spit of land and veer right at the fork you will come to a house run by a mosu named bi ma. She is very friendly and invited us in after renting one of her canoes, for some traditional snacks, tea and fire water. One of the highlights of the trip.
For dinner eats wonder around the lake front in luo shui at night where there are easily 50 places set up offering shao kao (roast grilling) the yang rou (goat) is especially good and fresh. We had a good experience at a place near the boat launch, you can get the owner on his cell at 13988822930 his ten year old adorable daughter will help you with the grilling and share with you about her hometown, Da Li. (chinese spoken only)
Zhong Dian (aka Shangri-la), unfortunately one of my traveling companions and I came down with both altitude sickness and a cold at this point so we werent too adventurous and just went with the first comfortable looking place we saw, called the patoloa café near the Youth Hostel -- which appeared to be one of those cafes set up targeting westerns and the menu is limited and would scare most hounds, including myself in normal circumstances, away. I advise staying. Its run by a local Tibetan guide with excellent local knowledge and seems to be a center point for the local Tibetan community, ranging from lamas sipping tea to rough looking workers downing shots we were the only non Tibetans there actually. Be sure to try the French fries, which come with a powdery chili dip, the Luo San tang (borsch) and an incredible dish simply described as Casserole, ten kuai, and can feed four. Its a huge dish/soup of mushrooms, potatoes, ham, goat, flowers and other veggies that really hit the spot.
Our guide took us to a mushroom hot place called Lao Zi Hao ? Sheng ? on guan xing lu 99-101 hao. (关兴路99-101号. ) They had very fresh (never frozen) mushrooms in a refrigerated display case and the soup base was good. I suspect though the place was expensive by local standards (RMB 320 for five) and seemed targeted at Chinese tourists. Still it was very good and all along that section of road are mushroom hot pots places so might want to stroll and see what strikes your fancy.