How do I password protect my iMac?

You probably already gave the iMac a password when you first set it up. This would the password you enter when you install a new application or make a change to the system. If you did not set a password, you can give it one by going to the Accounts system preference, clicking on your user name, and clicking the "change password" button and entering in a password.

Once you have a password set, go to the Login Options in the same preference and set Automatic Login to "off". Then as long as you remember to log out of your account, no one can use your system without knowing that password (at least not without hacking your computer).

You can also set the system to require a password when the screen saver is active. Go to the General pane of the Security system preference, check the box that says "Require password" and make the choice of when to require a password as you prefer. You can set screen saver times in the Desktop and Screen Saver system preference, and the time before the system goes to sleep in the Energy Saver system preference.

Regards.

the password I use whenever I have to do updates or installation can be the same password I can use to lock my iMac from unwanted users?

Yes.

But I do have a password for application installation.

The password is for your user account, so it works not only for application installation but for logging into your user account.

What is a 'key chain'? Sometimes the computer will ask if I want to save a password to a key chain?

While a bit old, this article has a good explanation:

http://www.macworld.com/article/1040403/workingmac.html

Regards.

You're quite welcome.

On the subject of passwords:

How can I eliminate the need to enter my password EVERY time I change user? I am on a new iMac running 10.8.

To the best of my knowledge you can't, if by your question you mean using Fast User Switching.

I found a way!

As a help to others sharing my frustration, I offer this:

Once again, Apple could be more helpful in defining terms.

If you go to System Preferences>Users & Groups and click on your identity you will see a button that says "Change Password..."

Here is where the confusion sets in. I did not realise that there were two passwords: the Admin password and the User password. I did not want to change or remove the Admin password.

It would have been helpful if Apple had marked the button "Change User Password..."

So, that is what you have to change so that the New Password and Verify boxes are totally blank.

Ignore the warning and blaze on ahead and you will find that the Login screen no longer demands a password.

I hope this will be helpful...

It's a serious security risk to have a user account with no password, particularly if that user has administrator rights. But it's up to you how you wish to run your system.

Regards.