AI difficulty give the AI bonuses. Harder AI's are more difficult to defeat. The idea in setting the AI difficulty by default to world difficulty is to have an easy way to set general game difficulty for the player.
Easy: opponent ai: AI cannot use combat magic. AI plays at 50% intelligence. AI gets 10% income penalty.
Normal Opponent ai: same game rules, plays at 75 intelligence.
Challenging: double starting gold, full intelligence.
Hard: Triple starting gold, 25% income bonus, 50% sovereign hitpoint bonus, 50% more sovereign creation points
Extreme: Quintiple starting gold, 50% income bonus, double unit hitpoints, triple sovereign hitpoints, triple sovereign creation points
Ridiculous: 10 times starting gold, triple income, vision for the entire map with all units, triple hitpoints for all units, quadruple hitpoints for sovereign, quadruple sovereign creation points.
The player, unlike civ, always plays by the same rules.