Sheep are different in Harvest Festival than Vanilla Minecraft, and Vanilla sheep will not spawn in the environment normally. They must be bought at the Animal Ranch.
They eat Animal Fodder out of a Food Trough, and one can collect Wool with Shears every 4 days. They eat Sheep Treats and regular Treats. They need to be brushed every few days.
If you do not feed your sheep long enough, do not brush them, or leave them out in the rain, they will get sick (shown by a purple particle effect) and no longer produce wool. You need to give them Animal Medicine to cure them.
If you want Vanilla wool, say for crafting, you will have to trade some of your Harvest Festival wool with Johan in the General Store.
Relationship[]
Sheep give larger, more valuable wool the more they like you. You can improve the relationship by petting them once per day, letting them out when it is sunny, keeping them inside when it is raining or snowing, and feeding them fodder by hand (instead of using a trough).
It is important to note that relationships are per person. If playing in multiplayer, if you want large wool when you shear the sheep, you will have to personally raise your relationships.
Multiple Products[]
Sheep will produce up to 5 wool at a time if you feed them treats. It takes 29 Sheep Treats + 2 generic Treats per level up to a total of 5 products.
Offspring[]
Sheep can be given Miracle Potion which cause them to reproduce. The resulting lamb will have 1/2 of the relationships of the parent.