When I selected Time Machine in Preferences, and tried to select "back up automatically", it asked me to set up the airport time capsule. I jsut need to have it back up my files to ICloud. I have a MacBookAir. How do I set up automatic backup?

Time Machine will not backup to iCloud.

Apple offers iCloud Backup for iPhones and iPads but not for Mac computers.

It is possible to sync data from a Mac to iCloud if you turn on those options (e.g., iCloud Photos, iCloud Drive including the Desktop & Documents option). Syncing has some of the benefits of a backup (and the benefit of being offsite) but is not the same as a backup. Major differences include the fact that not everything on your Mac can be synced and the fact that if you delete something, accidentally or otherwise, there is only a limited time period (30 days in most cases) during which it can be recovered.

Also see: How to back up your Mac - Official Apple Support

And more information on syncing in:

Set up and use iCloud Photos - Apple Support

and

Access and manage your files in iCloud Drive - Apple Support

and

Add your Desktop and Documents files to iCloud Drive - Apple Support

The following has information about using Time Machine: Back up your Mac with Time Machine - Apple Support

and

Backup disks you can use with Time Machine - Apple Support