The stages of fantasy and its evolution to creativity would involve a trigger event in the first stages that lead to heightened imagination and fantasy. This fantasy then evolves either to creativity or to some forms of mental preoccupation, illness, paranoia and beliefs about distorted reality. The evolution of imagination to fantasy and further to creativity or mental illness has not been studied extensively in psychology and the study of fantasy should be given as much importance within general psychology as dreams are given in psychoanalysis.
The study of fantasy could thus be on three levels:
1. Identifying the stages in the development of fantasy and the relationships with imagination, creativity and mental illness
2. Identifying the functions of fantasy from release of mental energy as in case of dreams and wish fulfilment although it is also necessary to differentiate the mechanisms of dreams from that of fantasy
3. Identifying the uses of fantasy in literature, art, culture, religion, daily life, behaviour and attitudes, love and relationships and possible interpretation through symbolism or other means.
Since fantasy works on a more conscious level than dreams and consists of bizarre or supernatural events and characters, it will not be too useful to define or explain fantasy with psychoanalysis as psychoanalysis is especially effective in dealing with the unconscious. Fantasy in the realm of imagination, only in its exaggerated forms being more about the limits of the conscious mind could need a fundamentally different psychological approach when compared with the unconscious. In fact Freudian psychoanalysis would not be too successful in the interpretation of fantasy. Explaining fantasy would require understanding the conscious mind in its extremes. Since fantasy is primarily a sort of wish fulfilment, fantasy has its positive effects on the mind.
Fantasy, like imagination and associated creative processes aids us in our mental journey and fantasies trigger positive emotions that help in productivity through motivation of individuals. Fantasy could bring out repressed emotions and desires (you may have fancied someone in childhood and you romance someone similar in your fantasies), play out denials of certain facts or events (as you may fantasize your ex lover more after knowing that you will never be with her again) or may be used as a means of sublimation (through fantasy in art and literature or poetry). Thus fantasy could be adequately explained with psychoanalysis at the more functional level as to how fantasy is useful functionally for us. Although at a more structural level where it is important to understand the components of fantasy, psychoanalysis is not adequate as fantasy is about the conscious rather than the unconscious.
In fact the difference between dreams and fantasy is that in fantasy we are consciously aware of our imagination whereas in dreams we are not consciously aware of our imagination.
The differences and similarities between fantasy and dreams will have to be studied further in psychology although imagination would be the common component and imagination plays a role both in unconscious dreaming and conscious fantasy. Imagination seems to precede fantasy and dreams precede imagination although this could be controversial and extensive study would be required. Thus fantasy is an exaggerated form of imagination and imagination is the product of dreams. When fantasy loses its proportion and there is a blurred distinction between fantasy and reality, mental illness takes the form of paranoia or delusion in which fantasy replaces reality or fantasy is considered reality. Thus if a girl repeatedly fantasizes that she is a princess, she might start believing in the fantasy and develop delusion of being actually being a princess.
It is essential that fantasy is recognized and used positively so that children and adults alike can actually use their fantasy for creative work.