Isn't it just the name fantasy thats beeing misused, and not really gamesettings beeing narrow?
Fantasy has just come to stand for a specific genre with a sort-of defined tolkien inspired setting, it doesn't mean games doesn't come out with otehr settings, they're just not publicly labeled fantasy.
Partly because they often fall under other labels.
If you add stuff common in the fantasy genre to a future setting, it'll often fall under sci-fi instead
If you add some of the stuff to a modern setting, it'll easily fall under super-hero ish labels, think infamous, prototype etc.
But there's still tons of games out there, who got whats usually found in fantasy but without the tolkien-canonish races/settings.
A few examples of games set in a medivalish/past level of technology settings could be Zelda, god of war, Dantes inferno, Diablo.
The later three borrows and gets ijnspiration from relegious lore, instead of tolkien inspired lore.
In a more present day-ish/undefined setting you'll find games such as ninja gaiden and bayonetta, both featuring magic and monsters, but no elves or dwarves etc.
Ninja gaiden even hits some of the steampunk inspired stuff yatzee was talking about, with the airship and all.
Infamous and prototype sits nicely here as well, featuring "magical" powers and monsters
Resident evil has zombies and mutants and cultists and stuff, but would probably be tagged more in the lines of horror.
I guess Darksiders technically takes place in the future, in a post apocalyptic armageddon
Whether stuff like fallout falls under fantasy or sci-fi i won't bother trying to determine.
And these are just games off the top of my head
In conclusion, just because it's games in a tolkien-ish setting that usually falls under the label of fantasy doesn't mean games with different lore/settings doesn't exist, they just don't get labeled with the fantasy label as often.
Outside of gameing, you'll also find very varied stuff, as yatzhee mantions himself, Niel Gaimann has some wonderfull modern-day fantasy settings, mixing all sorts of mythology, fantasy etc up in the most marvelous way.
magic the gathering, while chock full of elves and goblins also visit quite non-typical settings in it's multiverse.
Fill out the rest for yourselves, theres so much stuff out there, complaining that it's non existing, simply because a lot of people tag it with different labels than fantasy seems ignorant.
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To be fair, i find it silly, to complain about the word fantasy beeing used about a genre with a somewhat limited amount of original ideas when it comes to settings/races, just because the word fantasy implies something else in the original meaning.
You don't hear people complaining that rock music doesn't live up to it's name, because it doesn't sound like a rock beeing thrown, or an avalance or whatever sound you'd choose to connect with rock's original meaning as in "stone"
And i find it a bit weird to rant about the likeness of settings in the fantasy genre, while making it sound like different settings doesn't exist, simply because you think the word fantasy should encompass all settings.
Heck, some people imagine modern day or WW2 or future gun-fights, so by the logic of fantasy = anything in our imagination, every single game should be a fantasy game, and dating/sex sims would probably be those most accurate to the name fantasy.
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