Every file, folder, application and disk on your system has a default icon, which the Finder refers to when drawing the desktop. These default icons are stored in your Desktop DB. (By the way, confused icons on screen - such as applications appearing with a default icon instead of their custom icons, or word processor documents showing up as QuickTime movies - are a sure symptom that your Desktop DB is starting to get a bit scrambled. To fix this, simply restart your Mac holding down the
See how easy it is? Unfortunately, an icon created in this way doesn't contain all the elements a proper icon needs to look right and work consistently. You can get a shareware plug-in for Photoshop called IconBuilder that converts image files into fully-functioning icons but, frankly, using Photoshop as an icon editor is a bit of overkill.
Photos and other complex images become unrecognisable and cluttered at such small sizes, and you're much better off using one of the many good-quality shareware icon editors.
What's in an icon?