The second question is critical to answering the first one. I think that some level of discussion has to be established on whether Quixote is pretending to be mad in order to avoid a particular reality. Different answers will present themselves here because this condition strikes at the basis of the novel. I would make the argument that if Quixote is insane, it is not driven to avoid dealing with a specific condition of reality. Quixote's desire to be a knight is exactly how he deals with the reality of the world around him. Quixote is convinced that the world around him, his reality, is something that cries out for change. Being a knight is how he appropriates the reality around him. Quixote is not embracing the path of a knight to avoid reality. He sees it as the only way to address it:
...and that is where the subtleness of my plan comes in. A knighterrant who goes mad for a good reason deserves no credit; the whole point consists in going crazy without cause.
For Quixote, the world around him is one of conformity and banality. It is a world of Sancho, a world in which individuals see what is as the only basis for reality. The windmills will always be windmills. Quixote sees the role of being a knight as the only possible alternative to such a reality. He does not wish to avoid such a reality. Rather, he wants to counteract it with his "plan." In this light, I don't think that he is feigning or pretending to be mad or insane. Quixote believes that the way to redress the ills of the world around him is to embrace with full authenticity the condition of knighthood: "...what the world needed most of all was plenty of knights-errant." Such a conviction demonstrates that Quixote is not seeking to evade the responsibility of confronting the reality around him. He actually wishes to be an agent of change in interacting with it.
This probably addresses the idea that Quixote is aware of the reality of the world around him. He grasps that the world around him is devoid of the imagination. His desire to become a knight and defend honor is a direct response to the world around him. If the world was one of idealism and gallantry, Quixote would not feel the need to adopt his "plan." However, once he does, he understands the reality both within him and around him: ".. [What] astonished [him], and for the first time he felt thoroughly convinced that he was a knight-errant in fact and not in imagination." Quixote is more aware of reality than the simplistic label that he is nuts. For example, he does possess an awareness of Dulcinea and the function she holds in his world: "God knows whether Dulcinea exists on earth or not. I contemplate her in her ideal." He recognizes what Sancho is doing when he seeks to deceive his master. Quixote does recognize that what he is pursuing is an example of the "ideal" and does not exist in the tangible world around him. Quixote lives out his dreams, embracing them for all that they are and the motivation they provide for him. He does so primarily because of the lack of such idealism in the world that exists. Quixote understands that he lives in a world where people exist for commercial reasons, where a flock of sheep are simply livestock, and where windmills are simply windmills. In order to counteract this reality in a conscious manner, Quixote embraces the ideal of the knight, sees the sheep as warring armies, and views the windmills as giants.
It is Cervantes's genius to construct a world where one has to view the ability to dream in an almost ultimatum- like manner. If one concludes that Quixote is insane, then a direct indictment on the individual's ability to dream is present. At the same time, if one concludes that Quixote is more aware of reality, then it becomes clear that those who dream of what can be are always going to be marginalized by the collective social element. Quixote makes the reader evaluate such a paradigm in terms of both the novel and their own place in the world. Doing so forces one to accept that Quixote is more aware of his reality as he constructs a way to deal with it.