For starters, let's just clear the air. Dulcinea del Toboso is not a real person, and she never actually makes an appearance in all of Don Quixote.
However, the lovely lady does exist as a powerful fantasy in the mind of Don Quixote, and she motivates nearly everything he does. The first thing we ever hear about Dulcinea is that her real name is Aldonza Lorenzo. But this name doesn't sound romantic enough for Don Quixote's fantasies of knighthood and glory, so he renames her Dulcinea del Toboso, since Toboso is the name of the town she lives in (the name means "Dulcinea from Toboso"). It's sort of like turning someone named Norma Jeane Mortenson into someone named Marilyn Monroe.
In any case, ladies in stories of knight-errantry have names like Dulcinea. That's just how they roll.
The novel tells us the exact moment when Don Quixote decides on the woman who will be his great beloved: "Her name was Aldonza Lorenzo, and this was she whom he thought he might entitle to the sovereignty of his heart" (22.214.171.124). He also gives her the name Dulcinea because the name "sound[s] somewhat like that of a princess" (126.96.36.199). As the novel unfolds, Don Quixote picks fights to guard Dulcinea's honor and even strips and starves himself as a punishment for daring to love a woman so beautiful.
When he first meets a group of horsemen on the road, he orders them to "acknowledge and confess, that there is not in the universe a more beautiful damsel than the Empress de la Mancha, the peerless Dulcinea del Toboso" (188.8.131.52). But these men have never heard of Dulcinea (because she doesn't exist), and their hesitation makes the Don attack them. For someone who never shows up in the book, Dulcinea drives an awful lot of the action.
Now, ladies do drive a lot of the action in medieval romance and stories of knight-errantry. Get a load of Beatrice Portinari, for example, who inspired Dante Alighieri to go through heaven and hell (literally, if you ask him) for her sake and write it all down as one of the masterpieces of world literature. Beatrice, like Dulcinea, is half real and half fictional—the big difference is that Beatrice is pretty much a single, idealized person, whereas Dulcinea is... well, let's see just what Dulcinea really is.
With all of Don Quixote's romantic fantasizing, it's easy to forget that Dulcinea del Toboso is actually based on a real woman named Aldonza Lorenzo. The novel describes her as, in reality, "a good likely country lass" (184.108.40.206). Further, Don Quixote is so fixated on calling this girl Dulcinea that it takes his sidekick Sancho Panza nearly half the book to realize that Dulcinea and Aldonza Lorenzo are the same person. When he realizes who Dulcinea is, Sancho says, "By the Mass, she is a notable, strong-built, sizable, sturdy, manly lass" (220.127.116.11).
Sancho admits that Aldonza is a wonderful woman, but she's definitely not the dainty princess Don Quixote would make her out to be. She's actually a "manly" young woman with a booming voice. Now, as far as Sancho is concerned, these are great qualities because they make her very good at manual labor, and they also make her a good helper around the house. That's everything a country guy like Sancho could ask for in a wife.
The fact that Cervantes makes Dulcinea feel like a real character in this book is a testament to how strong Don Quixote's imagination is. It might be easy to make a person up out of the blue, but Don Quixote's mind doesn't work that way. His mind takes real-world people and objects and turns them into something extraordinary.
And that makes us wonder: how real is Dulcinea? What would Aldonza Lorenzo do if she knew what kinds of feelings she inspired in the old Don? (The movie musical has a few things to say about that, though it takes a lot of liberties.) Is she just a country wench? Is the point that someone like Aldonza, even just as she is—as Sancho sees her, for example—is ideal in her own way?
What is fantasy, and what is reality?