There are various lenses in a camera. Each lense bends the light of an object. The lenses move in very precise ways to talk a small piece of light on the outer lense and spread it out over a larger and larger area until that small dot is the size of the lens itself on the back end. In theory the only limit to optical magnification is the sensitivity of the sensor, the perfection of the lense, and the physics of light itself.
Digital zoom just takes the raw data from the image sensor and spreads it out over more pixels. So now each megapixel of the camera occupies more pixels on the screen.
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