We've all heard it more times than we could count: "Write what you know!" Indeed, as writers, we spend an inordinate amount of time and effort on observing the world around us, to amass a solid basis of that which we know. And yet, if writers were to transcribe the literal events around them, no one would read past the first couple pages (if that).
This is where a writer's imagination comes into play. Our observations weave together into a patchwork cloth which our imaginations then transform into an entire wardrobe (i.e. collection of stories).