Underneath each handle, there is a valve with an opening and a gasket. Normally, the gasket blocks water from coming through. As you turn the handle, the valve slides around, exposing the opening to the supply water. Water flow depends on how much of the opening is exposed, that is how you go from a trickle by turning a little, to full blast by turning all the way.
By modulating the hot and cold valves, you can mix water to virtually any degree between the temp of your incoming cold water, and the highest setting on your water heater.
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