Thought you guys might like to read this little tutorial I wrote on how to play by ear. I've seen 3 year-olds and 75 year-olds have success, so you can too. Not to mention it forms the core of a music degree ear training course, but most guitarists aren't familiar with it.

The method is solfege, and see how to apply it directly to the guitar here:

http://www.jsguitarforum.com/forum/showthread.php?t=56336

Being familiar with solfege will enable you to play by ear (i.e. play what ever you hear in your head or hear on a CD, and allows you to write it down - very helpful for composing), transcribe very easily, and gives you the ability to read a piece of sheet music and hear exactly how it sounds in your head without picking up an instrument.

Hope it helps.