In Don Quixote, the reader has no trouble distinguishing what is real from what is unreal. The protagonist, Don Quixote, however, is hopelessly clueless. According to the narrator, he has read too many adventure stories and begins to place his own life in that context. To the outside observer, Quixote is fooling himself, and sometimes he and others suffer because of it.
So in one sense, what is real and not real is relative to the observer/participant. Quixote thinks his adventures are real, so they affect him as though they are. To the outsider, Quixote is crazy and sometimes dangerous. But, because of Quixote’s earnest belief, others are sometimes required to act as if his delusions are real.