When you're getting the AppID, the two options are explained:
Open Apps: Write applications that can be added to a wide range of Yahoo! Network pages.
Web/Client Apps: Choose this option if you're integrating Yahoo! APIs with your own web application or client application.
If you're developing your own application, which is most likely the case, you will want to choose Web/Client Apps.
To set up a testing server, you would want to go to the site menu and select manage sites. Then select the site you're working in and click edit. Click on advanced at the top and on the left you should see Testing server as one of the options. Click on this and fill out the information.
In addition, on our support site, if you haven't installed a testing server on your machine, there are documents that instruct you on how:
Take a look at these three documents from that page:
Setting up a Testing Server for Windows
Setting up a Testing Server for Mac OS X
Defining a Dynamic Site in Dreamweaver