Making the install size of the system smaller enables new applications and ways of using the system. At the moment an operating system is a giant monolithic install tied to a signle machine. I would prefer a single install shared across all of my devices. To make this work the OS would need to be synchronised / reconciled across a network connection on demand. Like a cloud OS but not running on public hardware - just migrating between devices that I own. As size as a direct impact on performance (time to start up, to reconcile) the install size could never be small enough.
There are smaller devices than you acknowledge. Memory and storage are the dominant costs in those devices and reducing the need for both enables cheaper classes of device. The Pi is an interesting machine for $25, but what happens when a desktop-capable machine costs $5, or $1?
Lastly, flash is nice but it still is not as fast as DRAM. Having an entire OS install cached in memory has advantages for performance.