The characters' ability to create anything they want seems to be limited only by the availability of letters and their ability to use them. (Not only that, but it seems to often conform to exactly what they want, even though they rarely use adjectives.) If even the characters themselves are made up of letters, then what gives them life? It's slightly disturbing to watch the Ant character simply twice put together A-N-T to create two more Ants when he needs help with something.
It gets even worse in the episode where Bird's egg hatches. The lowercase letters b-i-r-d spill out, and then form into a living Word Friend.
The fact that the characters can also pull the letters off of anything, up to and including themselves, is really creepy.
Duck created a goat in the episode "Get Your Coat".
Also, the episode "There’s an Ant in Every Giant". Especially when Giant turns back into Ant by spelling a-n-t, which implies that you could do the same to any character whose name contains another word.
In "One Hat Fits All", Duck, Pig, and Sheep are fighting over the word "HAT", which, depending on whoever assembled it, changed into the exact color and type of hat they wanted (Duck got a beanie, Pig got a chef's hat, Sheep got a top hat). They don't really explain why this happens. According to Sheep, it's because "words are magic" and mean different things to different people. So it seems as though it's a bit of a Lampshade Hanging on the fact that the words conform to what the characters want and also a bit of an explanation—the exact nature of what's built from the letters is actually based directly on the expectations of whoever builds it.
The book Dog's Birthday Party is about Dog only having one of a certain thing he needs for his birthday party, like a hat or a cupcake and pointing out that he can get more just by adding "S" to the end of each word.
Though letters don't seem to be in short supply, theoretically a long word, having more letters, would be more "expensive" than a short word. Which means a thimble is more expensive than a car, and a hairbrush more expensive than a ruby.
The characters' homes are also made up of letters. It is possible to pull them apart like anything else in WordWorld and whenever this happens, whatever's inside them is apparently sent in Hammerspace, since it inevitably reappears once the home is built back into a word. Additionally, in "Sandbox Surprise," Duck and Dog pull apart a toolbox with tools inside to make "tool" and "box," resulting in there now only being one tool for the moment.
