This post raises two important and related questions. One is the question of genre fiction versus fiction/literature or entertainment versus literature. The other, how technology impacts this balance.
On the first point I think the best guide for the use of imagination in narrative fiction or really any literature is could it be real. That is, literature always fabricates events, but only events that could be real, at least to the viewer. This may seem overly restrictive, but even if we look at even the most fantastic events in literature, they are literature precisely because they are convincing. The narrative is not just believable, but super believable, as the clumsy moniker of surrealism suggests. The reader has to have a reason to suspend disbelief and that reason has to be both compelling and convincing.
This is why Macbeth can include incanting witches and Hamlet a ghost. Same for Dickens, Joyce, etc. We don’t mind Old Hamlet showing up every night to drive the action. His presence is utterly real to mind of any son that lost a father to murder. That reality may be the reality of a dream or some subconscious memory acting on a son’s emotions, but it plays as real almost universally.
The second question relating to our kids watching stories inside game applications like Minecraft and its relation to literature and media has a very direct precedent in movies. As soon as movies got past the novelty stage when they were sequestered in menageries they looked to literature to augment the spectacle. I can be argued that screenplays almost never satisfactorily translate literature, not even drama where the analogy seems direct.
I believe literature doesn’t translate well because movies, like radio, video and now video games, are essentially entertainment media mixed with mass communication. It is not novel to say that the commercial dimension of these media plays a much greater role than they do in traditional art forms, which were mostly centered around patrons.
Some radio dramas, such as those produced by there Mercury Players, seem to approach the experience of attending a play. So maybe these mass media/entertainment forms can become like literature if they survive long enough to establish the required conventions to seem real. But movies and radio were quickly supplanted by TV and now video games. So perhaps the balance for literature requires a limit of commerce and reliance on technology, as these certainly are not timeless.
Most traditional “critics” would say that the need to seem “real” is undermined, rather than supported, by technical or futuristic artifacts. They don’t make good literature impossible, but they raise the bar to get an audience to suspend disbelief and to tell the underlying story that the reader wants. This is why genre fiction is such good fodder for farce. If the story doesn’t need these obstacles, it’s probably better off without them. But if the fun in writing with them can overcome their drag, the story could soar even with rockets. They’re just a heavy narrative load to bear.