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Read this book few years back, that dreams are a way of different regions of the brain to defend territory. So the neurons in the visual processing region stop receiving input signal when one sleeps. Those neurons can then be used by neighboring regions for whatever. To prevent that takeover pseudo signals are created to keep them busy. Can't remember the name of the book, but it was a pretty cool theory.

EDIT: found the book - Livewired by David Eagleman

Dreams occur during REM sleep.

No.