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If you have other databases that specify localhost, then that is probably what this needs to be.
Regarding the prefix, that is something that you typically find on a shared server. For example, my database name is username_phpdig. Username is the dbprefix and phpdig is the database name. That's what goes into both those fields in connect.php. You can also tell this by looking at phpMyAdmin and seeing if database names are shown in the format username_dbname.
Regarding directory permissions, if you have 777 on the three directories listed in the documentation that need that, you should be ok.
Are you still getting errors?
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