In order to promote this willing suspension of disbelief, a fantasy game must have some credibility. The easiest way to achieve such credibility is by way of verisimilitude — by implementing a consistent, grounding, reality to which fantatic elements prove the exception. Frex, settings like Birthright, Greyhawk, and FR achieve this through the implementation of a grounding reality modeled on Medieval Europe.
I think Wikipedia (remarkably) manages to explain it best by saying that anything physically possible in the worldview of the reader's experience (or, in this case, the player's experience) is defined as credible. Thus, the reader can glean truth even in fiction because it reflects the realistic aspects of their own existence. As that explanation suggests, what is or is not the right amount of verisimilitude depends upon the indivdiual to whom the question is put.
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That's an interesting point...I've always wondered if East Asian gamers have as much trouble with regarding "fantastical" martial heroes given their upbringing and what they consider "credible" for a martial hero.
As an aside, while we were talking about Dragons, what about Giants? Even excusing the suare cube law, why is it that when a Giant hits a halfling or even a human, that human isn't launced 50 into the air?