What is a placebo, and how does it work?

C'mon folks, more questions please!
A placebo is a treatment or condition that is given as a "control" group. For example, when testing a new diet drug, you always include a group of people who are taking a "dummy pill" or inactive pill. A placebo group is important because you never know if the act of doing a study or giving a person medical care and attention will affect their condition. You want to know if your test drug or treatment is real.
Here's an example: treating depression. Whenever a new depression drug comes out, they have to test it against a placebo. In a drug trial for depression, you might have three groups of patients: one receives counseling only, one receives counseling and your test drug, the third receives counseling and a placebo. The second two groups have to visit their counselor, come into the clinic to be checked and pick up their medicine, be monitored for side effects (neither the researcher nor the patient will know if they are in the placebo or test group) and therefore everything is the same except the test drug.  Here's the kicker: almost always, the group on the placebo + counseling  shows more improvement for their depression than the group with only counseling. Wait, you say, isn't it just a dummy pill? Yes, it is. That is called the placebo effect. It is a case of convincing your brain that you have a therapy, that you will do better, that this will work, and then it does. It works really well for diet drugs, depression, idiopathic pain, insomnia, etc. It even works a little bit for other conditions like asthma, GI problems, arthritis pain, and memory problems. Scientists don't completely understand how the placebo effect works. It is not a clear case of the problem or pain simply being "just in your head," because these symptoms are real. It is still a mystery of the human body and brain. The human brain is a powerful thing.
The placebo effect is so powerful in fact, that some doctors actually prescribe placebos for some conditions. For example, a person is experiencing inexplicable pain in their calf muscle. The doctor has ruled out injury, pulled muscles, done X-rays, etc.and so calls the pain "idiopathic"- without a known cause. The doctor then gives the patient a bottle of sugar pills and tells the patient that this is a great new drug proven to stop this pain. The patient takes it, feels better, and moves on.  Mind over body. 
The FDA and other ethics groups have called this practice into question - they say that doctors should have to disclose to a patient when a pill is actually a placebo. But then, the placebo doesn't work, because the patient knows it's fake! What do you think?