1. Appledoc is a documentation generation tool that can be used to automatically generate documentation from code comments.
2. The process of setting up Appledoc involves fetching the Appledoc source code from GitHub, building the Appledoc project, installing the Appledoc shell, and integrating Appledoc into an Xcode project by adding a script to the build phases.
3. Documentation is created by adding specific tags like @param and @return to comments above classes, methods, and other code elements. Appledoc parses these comments and generates HTML documentation.