How does Pixar select the names for characters?
The same way any other writer(s) might: It’s a normal part of the story process.
Some names come easily, such as Woody Pride. Many go through many rewrites. After Tinny, the antique one-mand-band windup toy became a space man we went through a few names. One standin was Lunar Larry. I contributed the name Tempus from Morph for a short test. It wasn’t until a later story session that some folks batting around names tossed out Buzz, as a nod to Buzz Aldrin, and someone else (as I recall, nobody remembers exactly who) called out “Lightyear”.
Revisions can happen for many reasons. The protagonist of A Bug’s Life was a merge of two characters from an earlier version, Flick and Grub. The Flick name survived, but the c was dropped when someone saw how it might look in certain fonts, or hand-written in all caps.
In early versions of Monsters Inc. Sullivan was going to start as a nebbish screw-up named Johnson. Then someone pointed out that perhaps we already had our quota of character names which could be awkward euphemisms. He became James P. Sullivan, and also eventually lost the glasses.
Mustang McQueen became Lightning McQueen when the character became a pure race car not associated with a known model. Mater got his name from a character named Mater that John Lasseter met at a NASCAR race.
So the short answer (too late, I know) is that there’s no one short answer. I’ll bet most people reading this didn’t know Woody had a last name, though. Quite understandable since it’s never mentioned in any of the movies.
We love when Pixarians answer questions like this – any time we can learn (or be reminded) of interesting or fun Pixar facts, we’re intrigued. Craig is probably correct in saying that most of us wouldn’t know (or remember) Woody’s last name, but as a side note, Lee Unkrich revealed in August of 2009 what Woody’s last name was on Twitter.