Capacity refers to the ability to understand health care information and make health care decisions (and is sometimes used interchangeably with competence in colloquial discussion, although there is a legal distinction whereby competence is a more global property).
Capacity is specific to a particular decision, and requires that the person making the decision understands information relevant to the decision and the consequences of choices (including refusing to act).
Capacity is required as an aspect of informed consent, along with disclosure (being provided with the information needed to make the decision in accordance with the reasonable person standard) and voluntariness (freedom from coercion).