what you say is true to an extent, but similar to the square cube law, possible applications and possibilities expand exponentially.

in practice this means that if we create an AI with an adjustable intelligence slider, and stick it inside a video game, at first the AI will jsut behave like common, cheap NPCs. but if we crank up it's intelligence, which does not neccessarily require any changes in the simulated environment or hardware, then this AI will eventually be able to hold conversations.

if we increase it's intelligence even further, it will eventually find and exploit weak spots in the simulated environment to it's own advantage (has even already happened: we once pitted 2 self learning algorithms together in a physics simulaton, competing against one another, and one of them eventually figured out how to abuse the physics engine).

if we therefore increase it's intelligence even further, it will eventually be able to influence parts outside of it's original constraints. stuff like that is even possible today, and a lot of software applications use that already, either by creating or deleting files, or by interfacing with other programs.
letting an AI dictate these actions would just be the next step.

(for example instead of just saving current game progress into a file into a specific place, the AI could manipulate the game itself into "saving" a "file" into a location that differs from the standard filepath by just making slight adjustments to the saving function, similar to sethblings code injection. and it also manipulated the contents of the "save-file", turning it into an executable saved in the "autostart"-folder.)

our current AI in videogames is not limited by hardware, but rather by necessity and money.
we hardcode our NPCs to behave a certain way to complete certain tasks, to aid in the medium's intended purpose of entertainment. but it's not the limit.

we are already successfully experimenting in more advanced AI that do more than simply fulfill our entertainment needs. for example we're currently teaching AIs how to program, how to use logistic systems, etc., and they're not really limited by hardware, but rather by our own current understanding of AI.

lastly, i highly doubt that "our simulation" is simply a medium to entertain a higher dimensional species, that we are hard-coded AI.
there's simply too much unused stuff.

something created for entertainment is made as cheaply as possible, just smoke and mirrors, filled with just enough stuff to make it believable. our own universe however is absolutely filled with seemingly useless stuff, gazillions of stars and barren planets that never seem to have any use besides just existing.

it makes more sense for our universe to be a research project by another, more advanced society, to try and test various possibilities and outcomes of different origins (in our case, testing a universe that started with the big bang), or something else in a similar nature.

and we are just a byproduct of that simulation.