Development of Imagination
Stories help to develop a child's imagination by introducing new ideas into their world - ideas about fantastical worlds, other planets, different points in time and invented characters. It'll encourage the children to realise that they can, and should, imagine anything they want. The beauty of stories is that they can be super realistic or incredibly fantastical. They can be reading about children growing up in exactly the same situation as them one minute and about another species, Martians holidaying on Jupiter for example, the next.
Coping With Feelings
When children read stories that contain feelings it can help them understand and accept their own feelings. It helps them understand that there are other children who feel the same way and they are not alone. This helps the child understand that feelings are normal and should be expressed. Watching their responses to the feelings of the characters in the stories will give you some idea of how a child feels about certain situations and emotions. For example, how the child responds to the character in the story feeling sad or scared will give you some idea of how the child thinks.
As you can see, children's stories are important for a number of reasons and form a vital part of the growing process. Being part of that process can bring writers a sense of satisfaction as well as being great fun.