Defense is a modifier that increases as a factor of your level. You roll a d20 + Defense Modifier + Dexterity Modifier. Different classes have different Defense progressions. So every time someone makes an attack, they make a To Hit roll versus Defense. If the To Hit is higher than the Defense, the attack hits. Defense ALWAYS wins in a tie.
Armor and Defense are exclusive in this system -- you can either take your Equipment bonus from Armor or you Defense Bonus, but not both; they do not stack. However, if you are caught flat-footed, you lose both your Dexterity Modifier and your Defense modifier. So wearing some kind of armor is a good idea in case you get caught offguard.
Armor, Natural Armor, Dodge, Deflection, and other AC enhancing bonuses instead enhance your Defense roll, if they are applicable.