Photos - Duplicates - Merge Items: What if one photo is used in an album?

For question 1, either could be true. Copies of the same file could exist in many places outside Photos and be imported from several of them, or the same copy could be imported multiple times (and you would have to override the normal check to prevent duplicate imports); either of those would be two files on disk. If you imported a photo and then duplicated it inside Photos, those duplicates would be references to the same file.

For question 2, I've never seen a rotated version be detected as a duplicate, so I couldn't say.

For question 3, when photos are merged, the result is left in every album that any of the input photos were in.

Adding to markwmsn's answers: When you use Photos' Duplicate finder, you don't have to Merge the pictures-- you can copy important stuff from one to the other, rotate each as you wish, and then delete the one you don't want. Or, better, once you've made them identical, you can do the Merge. The advantage to the "Merging" is that the one remaining picture file will be listed on all the albums of both of the originals.

Keep in mind that pictures aren't exactly "in" an album. When you "put a picture into an album," its name is added to a list of pictures to display together when the album is clicked, kind of like a music playlist, but for pictures. So two albums can both have the same picture name in their lists (like two playlists with the same song,)  and that picture will show up when you click either album, but there's only one picture file-- it's just on multiple lists. And when you remove a picture from an album, its name remains in the lists of other albums, and the file still remains in your Library.