I am having difficulty understanding the theory of social facilitation, specifically, how can it be called a theory of psychology if there seems to...

Social facilitation refers to phenomenon by which people's performance improves when they are watched by others. Experiments in this field measure the extent to which people's performance improves when they are acting alongside others (co-action effects) or by having others present (audience effects).

Research in this area goes back to studies by Triplett (1898), who found that cyclists' speeds increased when they were racing against other cyclists. He replicated these effects in laboratory studies using children with fishing reels, and he found that the children worked faster to wind the reels when they were with other children. These studies were related to the co-action effect--that is, people work faster when alongside other people doing the same task. 

Studies have also found that the audience effect--just having others present--can improve people's performance of tasks. For example, Travis (1925) studied subjects who performed psychomotor tasks better in front of an audience. However, Pessin (1933) found that subjects were better at learning nonsense words when they were not in front of an audience than when they were. Cottrell (1968) hypothesized that people's anxiety about being evaluated by other people is responsible for social facilitation to occur. 

In 2002, Rafaeli conducted a meta-analysis of social facilitation and found that the presence of others only affects the physiological arousal of the performer if it's a complex task. This study found that others' presence affects the performance of simple tasks but not complex tasks. In other words, this study suggested that the nature of the task affects whether social facilitation occurs or not.

Sources:

Cottrell, N. B., Wack, D. L., Sekerak, G. J., & Rittle, R. H. (1968). Social facilitation of dominant responses by the presence of an audience and the mere presence of others. Journal of personality and social psychology, 9(3), 245.

Pessin, J. (1933). The comparative effects of social and mechanical stimulation on memorizing. The American Journal of Psychology, 45(2), 263-270.

Rafaeli, S.; Noy, A.; Correspondence (September 2002). European Journal of Information Systems, Volume 11, Number 3: 196-207.