This sounds like the Simulationist (immersion in alternate reality) vs Narrativist (Edwards' Story Now) conflict of the Gamist/Narrativist/Simulationist design model. I guess I definitely prefer the second as a player, OTOH as GM the first is much easier to do as GM, and my attempts at Nar tend to drift into Sim, with lots of Gamism. D&D 3e is constructed to be pretty pure-Gamist/challenge-oriented and doesn't support either Sim or Nar play styles very well IMO.