There are a number of ways to determine your approximate or semi-exact location, depending on the device in question.
For Desktop computers, the location is probably determined (grossly) via IP geo-location services like any of these.
For mobile/wireless devices, you may be located by:
- The tower you are presently connected through (much like IP
geo-location above)
- By correlating your WiFi with a known network
like those collected by Google during their well publicized
survey
- by GPS location data passed from the devices sensors/radios to the application in question.
This last one is the most precise, sufficient for turn by turn directions, and even finding which room in the house you lost your phone.
In your case, assume its IP geo-location unless your device has a GPS radio. Windows 8 is designed to work on desktops, tablets, and phones, so many of the devices have GPS capabilities. Usually the location permission features deal with whether GPS location access is enabled or not on a global level, rather than app by app, just as you suggest, but since you likely don't have GPS capabilities in your device the Win8 settings will not be meaningful (since you can't tell most apps not to look up your location by IP).