Under the game settings I know I can change the "AI damage multiplier" where 0,5 is the hardest setting, but what does the "Friendly damage" do? Does it make the player do more damage or does it make the player take more damage in combat, when turned up?

I would assume that it is the same sort of thing as "Friendly fire," meaning you are able to harm your allies with AoE spells or perhaps by direct targeting. I don't actually have the game, but it seems like a safe guess. Did you actually try a battle with the setting turned on to see for yourself?

Friendly Damage/Fire refers to damage you inflict to allies or your own units. If you ramp up the Friendly Damage option, then you will actually deal more damage to your friends and own units with AoEs or direct attacks. It can be helpful if you play like I do, and kill your own units to reclaim their souls or when playing with allied AI. But in multiplayer games with other human players, I suggest disabling Friendly Fire to prevent griefing.

Regrub, you say you have an "AI damage multiplier" located in the settings, where exactly is it hidden? (I cant seem to find it, and don't enjoy getting steamrolled by pyro)

"Friendly damage" means you can't hit your allies directly, but area of effect spells(tornado, volcano, cloudkill, etc.) can still harm them.