How the new Google Maps Mobile works, without GPS?
It uses cell-id based location detection.
1) Google has paid some network operators in the various (currently 22 countries) for access to their wholesale location services. What the application probably does is fetch your IMEI and use this to obtain your location via the network operator wholesale location services. I also suspect any data Google might be getting from the network operators might be less accurate than it could be - so as to alleviate privacy concerns. There are probably other things going on like a fallback to a (less accurate) Google database of cellids/GPS positions where Google doesn’t have a location service agreement with the network operator.
2) According to the FAQ on accuracy, the Google database is made up by taking "geo-contextual information [from anonymous GPS-readings, etc] and associates this information with the cell at that location to develop a database of cell locations".