I do think that is a good point about useless NPC's that don't really say anything.
For one thing, what would you do if someone came up to you that you had never seen before carrying a huge warhammer and wearing a scary helmet, and asked you to tell him your favorite gossip of the day. Then he asked some questions about town, ok that's normal maybe you'd give him some directions and such. Then things get wierd. This huge scary guy (who smells like he hasn't bathed... ever) asks a whole bunch of strange questions about your familly and the guy down the street and so on. Would you even answer those questions if he asked you? Probably not.
Now imagine Oblivion really DID have 1,000,000+ NPC's, would you even waste your time talking to some random guy on the street for your information or would you actually use contacts for your info, or people you know are actually going to be useful. After all, how many people in a big city are actually going to know that the guy 10 houses down goes to Joe's house every thursday night at 8:00? Unless that guy is real freak, he's not going to know that at all.
So you see, with a realistic number of NPC's, the amount of "reality" per NPC is lowered drastically. You can easily have thousands of randomly generated people that just go around and do random stuff (this could very easilly include shopping, traveling, hunting, stealing, or whatever your little heart desires)
So now I am officially converted to larger # of NPC's. But you will never convince me to convert to larger land size. See Earlier post about how long it would take to do anything!
For some reason, this gives me the image of the PC as some sort of cruel interrogator for a totalitarian regime. The civilian population of the Imperial City is kept in line by a strict Imperial Guard presence, and they are specially trained so as to give the illusion of a perfect, Disneyland-esque utopia. The player is the Grand Inquisitor, whose job it is to find out information about every citizen in Cyrodiil under the guise of an explorer looking for work. The civilian population, however, knows and is prepared by the government for the inquisition -- they have such pale and deformed faces because they spend all of their off-screen time in their houses watching massive televisions of Uriel Septim's head screaming "I LOVE YOU" at them until they are fully brainwashed by the government, and one of the many aspects of their training is to stare blankly and talk about themselves with their hands at their sides when an Inquisitor approaches.
To add to this, the reason there are so few people is because the stress of such a lifestyle causes a tremendous number of heart attacks. these people are terribly unhealthy and often die young. You see no children because, since this policy was enforced the people have been nothing but mindless drones, and so procreation has completely seased(sp?) -we can see this policy is far reaching, even te ashlanders of Vvardenfel are efected!
Perhaps with the death of the Septim Line, and the likely chaos that will fallow, this evil policy will be swiftly abandoned out of inability to enforce it.