"You have children."
(ty) masz = you (singular) have
(wy) macie = you (plural) have
The pronouns are redundant, as the form of the verb says it all.
If you were addressing more than one person in this example could you say, "Macie dzieci," or is it formal to say "Wy macie dzieci?"
Yes, that would be "(Wy) macie dzieci". I wouldn't even say that using "Wy" is more formal... it's just redundant, it sounds as if you contrasted "you" with someone else.
How to pronounce Dzieci? i hear it as dzieCHi but I'm not sure if that's right or not?
Not really. The sound is palatalized: Ć=CI, (well, CI has some I at the end, while Ć just ends abruptly) while I guess that by "CH" (English) you mean what is represented in Polish by CZ.
For learners, the palatalized sounds are not only hard to pronounce, but also even hard to hear, to perceive. They usually hear CZ at the beginning. For Polish people who don't have much experience with non-natives trying to speak Polish, it's a big surprise, as for us these are two completely different sounds and the difference is totally obvious.
Anyway, you can take a look here: http://popolskupopolsce.edu.pl/lekcja/1/MAZOWIECKIE - Part 2.
Well... it's not 'formal'. I wouldn't distinguish between 'formal' and 'informal', rather between 'formal' and 'neutral'.
And "macie" is simply the 2nd person plural when talking to people you know.
How do you know if "You have children" should be translated into a singular or plural?
You don't know. In 99% of sentences about 'you', both versions are equally correct, just choose one.
Seems like there is something slightly wrong with this exercise. It says 'You used the wrong word. Wy macie dzieci.' but 'Wy' is not an option, and 'macie' is not capitalised, although 'Ty' is. I assume I should have said 'Ty masz dzieci', but then why does it tell me 'Wy macie dzieci'? And if the answer is 'Macie dzieci', as it says above, then a) why doesn't it say that in the exercise, and b) why is 'macie' not capitalised? Maybe I'm missing something here?
The algorithm corrects you to one of the starred answers (usually there's one, relatively often two, rarely more), which is not necessarily the closest correct answer to what you wrote. This sentence has four starred answers: "[Ty/] masz dzieci" (singular 'you') and "[Wy/] macie dzieci" (plural 'you'). As shown by [/], the pronouns aren't necessary, in fact they're redundant as the form of the verb already makes it clear what the subject is.