This is a clear case of plagiarism. Correct? I am not sure how to
handle it. I know they are not realizing that's plagiarism, otherwise
they wouldn't have shared those fb conversations. So I don't want to
report to the school (yet!). But I am also not sure how to penalize
them? Give a zero for the assignment? What do you recommend? Should I
give zeros to both of them?
I'm going to disagree with Ben Crowell's answer, despite it being well-written and mostly sensible except for one crucial detail. The students have perhaps committed what we technically define as plagiarism (or more precisely, as StrongBad commented, one of them committed plagiarism and the other allowed her work to be used), but the element of mens rea, the "guilty mind" that we consider morally necessary to inflict punishment, is clearly lacking. So my verdict is not guilty.
The bottom line is, it doesn't matter how much we educators wring our hands about "kids these days". If someone clearly doesn't know that a behavior is wrong then it is foolish and harmful to penalize them for it. It is our job to educate students about what constitutes plagiarism and what are the standards we expect of them for independent work and citation of sources. All the things that Ben Crowell's answer lists are basically irrelevant, since if a student is showing you a facebook conversation proving that they did not realize what they were doing is plagiarism, that means your institution has failed to properly educate the students about this subject, whether it's written in the catalog or not.
I should add that in my opinion part of the problem with this common misunderstanding of plagiarism by students is that plagiarism is in fact quite a subtle concept, and that our expectations of how fast and easily students can understand and adapt to it are simply unrealistic. To criminalize a behavior that can result from a misunderstanding or lack of sophistication that is very common among students entering university is very problematic, and can backfire in all sorts of unexpected ways. (On the other hand, of course plagiarism is a real problem that needs to be dealt with; I don't have all the answers about what is the correct approach or balance to strike, and a detailed discussion of this topic is in any case beyond the scope of this question.)
To summarize, in my opinion it would be wrong to penalize the students in this case. You can and should use this as a teaching opportunity, and it would be reasonable to require the plagiarizing student to submit a revised paper that satisfies your standards for academic writing, after very clearly and carefully explaining to her what those standards are. This is also an opportunity for all of us to reflect on what we are trying to achieve with various "zero tolerance" policies that impose an unrealistically high standard of behavior on students who may not be adequately prepared to be capable of satisfying those lofty standards.
Edit: thanks to all the commenters for their lively and intelligent discussion and criticism of my answer. You have persuaded me that the answer is perhaps more subjective than I thought. I am willing to tone down my recommendation and say that the plagiarizing student may be deserving of punishment. I think ultimately it would all depend on specific details about the facebook conversation and other evidence that we do not have. At the same time, given the information presented in the question I still think an educational, rather than punitive, approach, would be the most appropriate one in this case. The key question that needs to be answered in my opinion is whether the student "knew what she was doing" in the sense that she had an understanding that basing her paper off of another student's paper was wrong. It doesn't sound like she did, but I'm only speculating and am open to changing my mind about this if presented with new information.