To upgrade my phone to IOS 8 I had to free some space. This basically involved deleted some Apps that I never use that were taking a great deal of space. I don't buy apple movies because they can be only played on apple devices, so the majority of data is music, most of which is stored on the cloud, and photos. I know people have almost no music on their devices, but stream everything. To be honest, streaming has meant that many people do not have to deal with the hassle of local storage. Though we can get into a philosophical argument, the fact is that I do not store as much on my mobile devices as I once did. Even my laptop now has less stuff on it.
As to why there is still a 16GB model, that is obvious. Apple needs an entry level device and is not willing to enter the cut rate phone market. Amazon has done this with a 99 cent 32GB model and at $99 64GB model. Obviously they are hoping customers buy the 64GB model even though what is essentially $100 for a 32GB upgrade is essentially highway robbery. Some will do it even though the pricing structure provides little value.
Most cell phone companies do this. Apple, being a premium device, is just a little more aggressive.