Testing programs

Yes, you can run the server and as many clients as necessary(within memory/heartiness limits) as you need.
Though for real testing you should do it over the wire so that you can take into account any latency issues you might come against. It might run lightning fast on a single machine but completely slow when going over the wire.

Webby

You just have to take care about the ports you use (if you''re using tcp/ip stack), because two applications cannot take over a single port simultaneously.

"I''ll be Bach!" (c) Johann Sebastian Schwarzenegger

I think a good idea would definately be to do both ... when you test on the same computer, you get a really good feel for how your program can behave in an ideal world ... so that when you test over the wire (you should spend at least 60-80% of you testing time in close to real world conditions - which even means you should ideally go through some artificial delay if possible) you can isolate what problems are inheirant in your core game engine and which are caused by bad networking behavior.

just to make it clear, when I say "caused by bad network behavior" I don''t mean your engine is fine and the network is to blame ... I mean it will point out which areas of your code need to change to be able to handle real world networks, to prevent (as much as possbile) bad network game behavior.